Understanding Home Equity

Understanding Home Equity and How it Can Generate Long-Term Financial Security

By SaleCore on 1/24/2021

Homeownership has paved its way as part of the American Dream by providing families with a place of their own and an opportunity for building financial security. This security comes in the form of Home Equity. Whether you’re just beginning the home-buying process or already a homeowner, understanding home equity is the key to getting the most benefit from your investment. Although a lengthy process, building equity in your home can be the smartest, long-term strategy for wealth and financial security. It is especially beneficial during these trying times when many households are struggling with their housing expenses, as homeowners have better alternatives because of their equity.


1. What is Home Equity?

What is home equity - illustration of money and house in balance

Simply stated, view your mortgage loan as an “enforced” savings account. As you pay down the principal on your loan each month, you gradually acquire a larger percentage of ownership from your lender. That growing share is called equity, which can also mature as the property value increases. This loan is unlike other assets (such as vehicles), which actually lose value as you pay it down. Purchasing a home is likely your largest and most valuable asset, and being strategic will enable you to use this asset later in life.

2. How to Build Home Equity?

As a rule, building home equity is a slow process, a long-term strategy for building your net-worth. Your money is, for the most part, locked up and not spendable at any given time. There are ways to tap into it, but wealth is created over years as your share of “free and clear” ownership of the house increases. Building equity through your monthly principal payments and appreciation are a critical part of this process.

  • Paying Your Mortgage: Most mortgage loans are amortized, applying your monthly payments to interest and principal, thus increasing equity. If you have a different type of loan, extra payments may need to be made to increase home equity. The more you pay down, the more your equity goes up.
    • If you are a new buyer, increase your down payment if you are able. The more you put down, the less your lender will need to loan you, and the larger your equity stake will be.
    • Paying more than the minimum required on your mortgage loan, either monthly or a few times per year, can help you pay down your balance faster and increase your gains. Consider putting your annual tax refund toward your loan to really make a dent.
    • Refinancing your loan with a short-term loan, like a 15-year, will pay down your balance faster, and perhaps get you a lower rate as well.
  • Home value appreciation - illustration of increasing home value Appreciation: Another critical factor for growing home equity is simply “time.” Typically, the longer you stay in your home, the more home equity you can accumulate as your home appreciates, or increases in value. While property values can go up or down, the national average is 3% per year for home appreciation. If you live in a neighborhood where property values are going up overall and you’ve maintained your property, your equity will increase as well. It's important to note that some markets appreciate faster than others. It's also possible for home values to depreciate due to economic conditions, if your home is not being well-maintained, or due to a drop in neighborhood home values.
    • Buying in an up-and-coming market (as a new buyer), is a strategic move that will increase your equity almost immediately. If home values in a neighborhood are on the rise, the property values will be too. Perhaps this neighborhood is considered a booming area and homes have sold for more, or the homeowners have done some renovations that have considerably increased their home’s value.
    • Renovations or home improvements can also increase the value of your home, but choose your projects and the funding for these projects wisely. It's important to know if the reward is worth it. Knowing what renovations will yield the highest return for the money is key so that when it comes time to sell, you can demand a higher price. Before you decide on a remodel project, evaluate its cost versus its value, and decide if the renovation you want to do is a worthy investment of your time and money. A few improvements that will increase your home’s value the most, include: upgrading the garage door, updating kitchens and bathrooms, finishing a basement, siding and vinyl window replacements, landscaping, and adding a wood deck. Think of it as your vested interest in a property – the more you put in, the more you get out.

3. How to Use Home Equity?

Home Equity Line of Credit (HELOC) - concept of applying for a home equity line of credit

It is not necessary to sell your home to access the equity/profit. Once you’ve built up significant equity (typically 20% or more), you can tap into it by taking out lump-sum or partial amounts. Below are the primary ways in which you can access your home equity, keeping in mind however, that this is the security of your future, so taking lavish vacations or spending frivolously is highly discouraged. In addition, each of these options have their advantages and risks, so make sure you do your research before filling out an application.

  • Borrow Against the Equity: A home equity loan provides a lump sum you can use for almost any purpose. A Home Equity Line of Credit (HELOC) allows you to withdraw money when you need it, up to a pre-approved amount. If you are considering renovations on your home, this is a logical means to fund the projects, as credit cards rack up significant debt with high interest rates. As you pay the HELOC down, you’re continuing to pay the mortgage and build equity at the same time.
  • Sell Your Home: When you decide to sell your home, the equity you’ve built over time will come back to you in the sale. If you are planning to purchase a new home, you can use the equity as a down payment, reducing the loan payment on your next mortgage. Or you can get cash to invest, save or use as you wish.
  • Refinance Your Home: You can refinance your current mortgage and take out some of the equity you have accumulated. If the mortgage rates are low, you may be able to take out substantial cash and keep your monthly payment the same.
  • Fund Your Golden Years - happy older couple enjoying the beach Fund Your Golden Years: If you opt to reside in your home after you’re well into retirement and aren’t planning to pass your property on to heirs, then a reverse mortgage can be a great way to tap into home equity. This type of loan pays you monthly – you can use that income however you wish. The amount you can borrow depends on your age and how much equity you have in your home, as well as current interest rates. You can elect to receive your proceeds in one lump sum, regular monthly payments or a line of credit (or a combination of these payment types). The loan will be repaid when you or other principal homeowner no longer reside in the property. A reverse mortgage is a nonrecourse loan, meaning your heirs won’t be forced to pay back anything more than what they can get from the sale of the home. Be forewarned, these loans can be complicated, and you’ll have to meet certain requirements, so check the fine print.
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