October 5, 2024 Linh Gray

Ways to Build Home Equity

Ways to Build Home Equity

5 Ways to Build Home Equity Without Breaking the Bank

Home equity refers to the proportion of your home’s worth that belongs to you, and it plays a vital role in creating wealth through property ownership. In this article, we will examine ways to build your home equity without exceeding your budget, as well as how to obtain it when necessary.

How much equity do you have?

When you purchase a home, equity is calculated by your down payment. For instance, if you put down $11,250 on a $225,000 home, your down payment and equity would both be 5%. From 2016 to the first quarter of 2018, most first-time home buyers in the U.S. began with roughly 7% equity, as reported by Inside Mortgage Finance. This is a positive sign because it indicates that you don’t have to save for years to achieve a 20% or higher down payment before purchasing. Repeat home buyers started with a higher equity rate, at approximately 17%.

How to build your equity

Here are six ways your home can create wealth for you. Some require time, money — or both. A lender can help you decide what works best for you.

1. Let your home appreciate

Building equity through appreciation can take little time or a lot, depending on the market. With home prices going up like they have in recent years, appreciation has been a boon for many home owners.

According to research conducted by Zillow, the median home value saw a growth from $185,000 in April 2016 to $216,000 in April 2018. If you had purchased a home for $185,000 in April 2016 by making a down payment of $12,950, your initial equity of 7% would have increased to 23% by April 2018. This increase is a result of the difference between your home’s current value ($216,000) and your current loan balance ($165,600), divided by your home’s present value. Approximately one-eighth of this equity growth is due to paying off your mortgage, while the rest is due to market appreciation.

If you had waited to purchase the same home in April 2018 with a 20% down payment of $43,200, you would have started off with 20% equity, using 3.3 times more cash for the purchase. However, your total monthly housing cost would have been the same, about $1,050 in both cases.

This example illustrates two things:

When it comes to owning a home, there are a few things to keep in mind. Firstly, the value of your home can increase over time, much like buying stock. The difference is that you won’t have to pay taxes on capital gains up to $250,000, or $500,000 if you’re married.

Secondly, don’t wait until you have saved up enough money before considering buying a home. While lenders will look at your down payment and cash reserves, there are options available for low down payments and minimal reserves. The primary factor that lenders consider is your monthly budget. They typically allow you to spend between 43 percent and 49 percent of your income on monthly bills, which could be a stretch for some budgets.

Since 2016, most first-time buyers have spent about 38 percent of their income on housing and other debt, which is a pretty safe cap for budgeting.

2. Make a larger down payment

You can do this but, as we’ve seen, waiting to save extra cash can go against your broader financial interests if you lose the chance to build equity through appreciation. Therefore, you must strike a balance among down payment, monthly budget and savings for other priorities. A good lender can provide rate and market insight to help you do this.

3. Use financial windfalls

Take advantage of work bonuses, family gifts and inheritances to pay down your mortgage. If you do pay down in lump sums, see if your lender will recalculate (or “recast”) your payment based on the new, lower balance.

4. Make biweekly payments

Make mortgage payments every two weeks instead of once a month. Over the course of a year, this will add up to 13 monthly payments instead of 12. You’ll build equity faster and shave five to six years off a 30-year mortgage. Just make sure your lender isn’t charging extra for processing semimonthly payments.

5. Cut your loan term in half

Take out a 15-year mortgage instead of a 30-year mortgage, and you’ll build equity twice as fast. Two caveats here: You’ll have a significantly higher monthly payment and, because of that, you may have a tougher time qualifying.

6. Make home improvements

New appliances or cosmetic features like paint are unlikely to increase value. Only big improvements like new kitchens, or additional bathrooms or other rooms will add meaningful value. Make sure the cost of such improvements will create the added value you’re looking for.

How to use your equity

To access the equity of your home, you can either borrow against it or sell it. The three commonly used methods of borrowing against it are a home equity line of credit (HELOC), home equity loan, or cash-out refinance. It’s important to weigh the advantages and disadvantages of each method before making a decision.

As interest rates are increasing, the cost of borrowing using these options may rise in the future. It’s recommended to consult with your lender to determine the best approach that suits your needs.

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