How to Build Home Equity (And Why You Should)

Home equity is a powerful asset and an essential component of homeownership. Home equity represents the amount of money you have freely owned in your home, not just how much you owe on a mortgage. As you pay off your mortgage or property values ​​rise, your equity increases, making your home a more valuable asset.

Whether you’re buying a new home or have owned it for years, it’s important to understand how your home’s equity increases and how you can contribute to that increase. Increasing the equity in your home can help you build a valuable asset over time and increase your overall net worth.

Here are some ways to increase the equity in your home before you buy it and while you live in it.

What is home equity?

Home equity is the part of your home that you own outright. If you bought your home with all cash or have paid off your mortgage, your home has 100% equity. Otherwise, home equity is calculated by subtracting the remaining balance of your mortgage from the current market value of your home.

Let’s say your home is worth $350,000 and your mortgage balance is $150,000. To determine your home equity, use the following calculation:

If you’re considering a mortgage or home equity line of credit (HELOC), it’s a good idea to know how much equity you have, because lenders base their loan amount on your assets. Generally, the more equity you have, the more money you can borrow.

Why is it important to increase the value of your home?

Building home equity is important for a few reasons: “It can be a surefire way to build wealth and help you keep your home while you live in it,” says Linda Bell, a senior writer on Bankrate’s mortgage team.

Increasing the value of your property means:

• You have a source of income. You can use your home equity as collateral to get a loan for almost any purpose.. The most common options are mortgages and home equity lines of credit (HELOCs), which are typically available with 15 to 20 percent equity. With a mortgage, you receive all your funds at once and immediately begin paying off the loan over up to 30 years. With a HELOC, you have a drawdown period (usually 5 to 10 years) during which you can withdraw the cash you need, when you need it, and make interest-only payments. Then you have a repayment period (usually 10 to 20 years) during which you pay back both interest and principal.
• You are more likely Sell ​​your house for a profitEven if you still have an outstanding loan balance, building up equity means that if the market turns (down), you’ll be more likely to be able to sell your property for more than the mortgage balance. You can use the profits from the sale to buy another home, pay off other debts, or invest elsewhere.
• You can build long-term wealthBuilding up home equity can increase your net worth over time, especially if you purchase your home when the market favors buyers. A home is one of the few pieces of collateral that can increase in value (a car, for example, depreciates over time), and it can be a source of wealth for your descendants.

How to Increase the Property Value of Your Home

There are several ways to increase the equity of a home faster. Typically, the process involves increasing the value of the property, reducing mortgage debt, or a combination of both. Below are some of the options available to homeowners:

1. Pay a large down payment

Equity building begins the moment you make a down payment. Remember: Home equity is equal to the amount of your home you own outright, and you actually own the entire amount you put down out of pocket (as opposed to financing with a loan), so the more cash you put down to buy a home, the greater your percentage of ownership.

Technically, the bank owns a percentage of the home that is financed, not you. While you might be able to buy a home with only 3 percent down, or even 0 percent down, a larger down payment quickly increases the equity of your home.

However, when calculating your down payment, consider how much savings you’ll have left after closing. With little or no cash saved up, you may find it harder to handle a financial emergency if one arises, and even harder to cover your regular monthly mortgage payments. You should also factor in home maintenance costs, which are usually about 1 percent of the home’s price in the first year.

Avoid mortgage insurance

If you can make a down payment of at least 20 percent when purchasing a home, you can also avoid paying private mortgage insurance (PMI) every month, which is an added expense built into your mortgage payment and an unnecessary burden. Avoiding PMI (or MIP, if you have a government-insured loan) being added to your mortgage payment can give you more money each month and help you build up the equity in your home.

2. Get the cheapest loan possible

This may seem like a no-brainer. Who doesn’t want a cheaper loan? But it’s also about building equity. The faster you can pay off the principal on your loan, the faster your equity will grow. So you want to pay as little interest as possible. To do that, compare mortgages. Studies show that people who do that are more likely to save money. Also, consider different types of mortgages, as some mortgages generally have lower interest rates. For example, consider a mortgage with a shorter term than the traditional 30 years. Not only will you get a lower interest rate, but you’ll pay off your debt faster. You might also want to consider an adjustable-rate mortgage, which also has a lower interest rate for a few years. Don’t be tempted to pay only interest during that period.

3. Pay the closing costs out of your own pocket

When you take out a mortgage, your lender may offer to roll closing costs into the loan itself. Sure, this can be tempting, since these upfront costs can often be thousands of dollars, or as much as 5 percent of the loan. But doing so will increase your monthly payments (which are loan principal and interest).

If you can afford it, it’s more economical to pay closing costs and other upfront fees right away. This puts more money toward the principal of the loan, and helps you build up more equity because you pay less principal (and interest on it). This strategy applies to home loans, but it can also be applied to mortgage refinances, which will still incur closing costs and fees.

4. Increase property values

Home improvements can increase the value of your property and therefore your property value. However, keep in mind that you are unlikely to recoup all of the money you put into home improvements. Some improvements may have a better return on investment than others.

for example, Mods‘s 2024 Cost vs. Value Report, the average luxury bathroom remodel has a return on investment of just over 45 percent, while a classic wood deck can recoup nearly 83 percent of its costs. The most cost-effective project is a garage door replacement, which can return an astounding 194 percent at resale.

Before embarking on your next remodel, do your research first or consult with a real estate agent or other home professionals to figure out which renovations will bring you the most return. The goal is to avoid spending too much money on renovations that will add little or nothing to your home’s value. A professional can help you sort through your options and select the projects and details (finishes, features, appliances) that will most certainly bring you the best return on your efforts. Sometimes less is more. A small kitchen remodel can have a 96 percent return on investment, while a large remodel might only have 50 percent.

Regular maintenance protects and enhances the value of your home, ultimately increasing your property value.

“Addressing small issues as they arise can prevent them from developing into bigger, more costly problems down the line,” Bell says. “Cracks in the foundation or a leaking roof can easily become a major headache. It’s important to keep your home in good condition – not only will it protect its functionality while you’re living in it, but it will also increase its appeal to potential buyers when it’s time to sell.”

5. Increase your mortgage payment

Most mortgages follow an amortization schedule, which means you pay installments over a set period of time until your loan is paid off. As you pay off your mortgage, your equity increases. You always pay both principal and interest, but the majority of your payment goes toward interest at first, and over time an increasing percentage goes toward principal.

But if you make an extra payment toward your principal each month, it will reduce the amount you owe and help your home’s equity rise faster. If you can afford to pay a little extra, call your mortgage servicer and ask how you can make the payment. Check your monthly statement to make sure the extra money is being applied toward your principal.

Here are some ways to pay off your mortgage faster.

• Switch Fortnightly mortgage payments. Split your mortgage payment in half and send one half every two weeks instead of one at the end of the month. This will give you one more mortgage payment each year, ultimately shortening the term of your loan and saving you money on interest.
• Add a fixed amount each month. Check your budget and see how much extra you can actually pay towards your mortgage each month. For example, if you just paid off your car loan, consider putting an extra $250 towards your mortgage each month.
• Utilize extra income funds. If you receive a tax refund, a bonus at work, or a cash gift, apply it to your mortgage balance.

6. Refinance to a shorter loan term

A shorter loan term has two main advantages: You usually get a lower interest rate, meaning you can put more of your monthly mortgage payment towards the principal If you choose a 15-year mortgage from the start, you can pay off your debt faster and build more equity each month than you would with a 30-year mortgage If you already have a mortgage, you can refinance to a shorter-term loan.

But there’s a catch: the shorter the loan term, the higher the payment. Before choosing a shorter-term loan or refinancing, make sure your budget has room for that higher mortgage payment.

Also, because the payments are larger, short-term loans can be a bit harder to obtain, and to qualify, you’ll need a higher income, a better credit score, and a lower debt-to-income ratio than for a traditional 30-year mortgage.

7. Wait for your home to increase in value

Your home’s value can fluctuate as your local housing market changes over time. If nearby property prices rise and demand increases, your home’s value will increase. Conversely, if home prices fall, your home’s equity will decrease somewhat.

While you can’t control the fluctuations of the real estate market or the state of the economy, you can protect yourself to some extent from economic fluctuations. Always keep your home in good condition. Avoid using your equity too much or too often. And if you borrow against your equity, use the funds to improve your home (renovations like those mentioned above) and to strengthen your finances (paying off ongoing high-interest debt).

You can find out how much your home is worth by using an online valuation tool or getting a professional appraisal, and Bankrate offers an online mortgage calculator to help you calculate the equity value of your home.

8. Avoid cash-out refinancing

If you’re refinancing your mortgage, don’t do a cash-out refinance. In a cash-out refinance, you replace your old mortgage with a larger loan — extra money you receive directly in cash (hence the name). This amount is based on the equity you currently have in your home.

You’re essentially borrowing against your ownership interest, effectively reducing your equity. In other words, you’re taking equity out of your home. This is bad if your goal is to build equity.

Cash-out refinancing can help, but in this case it would be counterproductive. Stick to a rate-and-term refinance, which could allow you to take advantage of a lower interest rate or shorter-term mortgage while still keeping your ownership intact.

Home affordability/home equity insights

• According to Bank of America’s 2024 Home Buyer Insights Report, 57% of potential home buyers say they’re not sure if now is a good time to buy.
• According to Bankrate’s Home Affordability Survey, 56% of non-homeowners say they don’t have enough income to own a home.
• According to Bankrate’s Home Affordability Survey, 44% of potential homebuyers are willing to downsize their living space to find a more affordable home, and 34% are willing to relocate out of state or buy a home that needs repairs.
• According to a Gallup poll, 68% of adults expect home prices to rise in their local area next year.
• Homeowners will have $11.5 trillion in available home equity in the first quarter of 2024, the highest amount on record.
• In the second quarter of 2024, nearly half (49.2%) of mortgaged homes will be considered heavily self-financed, meaning homeowners have loans worth less than half of their homes’ value.
• According to Bankrate’s Home Equity Insights Survey, 55% of current homeowners believe that home improvements and repairs are a good enough reason to tap into their home equity.

How home prices will impact home equity in 2024

Home prices have soared during the pandemic, buoyed by strong demand and record-low interest rates. But those rates have begun to rise sharply in 2022, doubling and even tripling from previous lows. But home prices continue to rise in 2024, despite the highest interest rates in the past two decades. According to the National Association of Realtors (NAR), the average sales price of an existing home in the U.S. hit a record high of $426,900 in June and was only slightly lower in August at the median price of $416,700.

That’s bad news for homebuyers, but good news for homeowners: As home prices rise, so does the equity in their homes for Americans. According to CoreLogic’s Homeowner Equity Insights, the combined wealth of U.S. homeowners with mortgages has increased by $1.5 trillion since the first quarter of 2023, a 9.6% increase from the previous year.

No one knows what the rest of the year will hold. The Federal Reserve, whose monetary policy indirectly affects mortgage rates, has finally started to cut interest rates. This may ease the difficulty of buying a home, but don’t expect a dramatic increase in the number of homes for sale. Many existing homeowners will be willing to put their house on the market and forfeit the low interest rates they secured long ago to buy a new one.

Given tight inventory, a significant decline in values ​​is unlikely. Home prices will remain relatively high, residential real estate will continue to appreciate, and homeowners will see increased equity.

Conclusions on building and leveraging housing assets

These days, many homeowners are borrowing against the equity in their homes to access cash. According to Bankrate’s Home Equity Survey, 55 percent of current homeowners consider home improvements or repairs to be a good reason to tap into their home equity. Nearly a third (30 percent) cited debt consolidation, meaning paying off credit cards and other high-interest debt.

“Mortgage and HELOC interest rates are attractive because they tend to be lower than personal loans and credit cards,” Bell says.

But “you’ll be putting up your home as collateral to get a lower interest rate,” she points out. “Make sure you can take on the additional debt, because you could lose your home if you fall behind on your payments.”

“Also, if house prices fall after you’ve maxed out your assets, you could go from being wealthy to being in negative equity in an instant, and find yourself owing more than your property is worth.

Overall, “it’s important to weigh the pros and cons of tapping into your home equity before moving forward,” Bell says. Also, be sure to evaluate how quickly you can recover your equity, because abundant equity, whether bolstered by a booming market, mortgage paydowns, or both, benefits homeowners in a variety of ways for both long-term and short-term purposes.