Why and how homeowners build equity.
Buying a home is a significant investment. In addition to saving for a down payment and closing costs, homeowners have ongoing expenses such as property taxes, insurance, maintenance, and repairs. While buying can be pricier than renting, the potential for substantial home equity still makes it one of the best ways to increase net worth.
What is home equity?
Home equity is the difference between the current market value of the home and the amount owed on the property.
Equity = Home’s Fair Market Value – (Debt Secured by Home)
Owning a home allows you to transform a mortgage (debt) into equity (ownership) over time, unlike traditional purchases that simply deplete resources. For example, Paula has 100% home equity because she recently paid off her mortgage and has no other loans or liens on the property. Another example is Bill, who purchased his $700,000 home a few months ago. He used an inheritance to make a $250,000 down payment. He left the closing table with 35% home equity. With each monthly mortgage payment, Bill’s equity will increase.
The amount of equity can also change, based on a variety of other factors including local market demand and property improvements.
Benefits of home equity
People who build equity in their homes typically have more control over their financial future. Homeowners can access their available equity by selling the house or borrowing against it using a Commerce Bank home equity loan or home equity line of credit. For example:
- Eliminate high-interest debt
- Cover home renovation costs
- Pay for higher education expenses
- Pay for unexpected expenses without depleting savings
However, the ups and downs of the real estate market can stall equity growth. Fortunately, there are practical strategies homeowners can implement to increase the value of their biggest asset despite changing economic conditions.
How to build home equity
While homeowners cannot control the real estate market, they can control how quickly they pay off their mortgage. Paying the mortgage principal is the most reliable way to increase home equity. The larger the gap between the loan balance and the property’s fair market value, the larger the home equity.
It’s possible to pay off a mortgage early:
- Apply bonus paychecks and tax refunds to the principal balance.
- Round up the minimum payment to the nearest thousand dollars. For example, if your payment is $2,500, round it up to $3,000.
- Make an extra payment each year.
Speak with your loan servicer before changing your mortgage payment. Let them know how you would like the extra money applied to the principal. Confirm that the extra money will be applied in the way you intend.
Besides paying more than the minimum monthly mortgage payment, homeowners can make property improvements to increase fair market value. The Cost vs. Value report, which compares national average remodeling costs to the amount recouped at sale, identified four projects that provide at least a 100% return on investment:
- HVAC conversion (electrification)
- Garage door replacement
- Manufactured stone veneer
- Entry door replacement
Even without a cash windfall or home upgrade, your home is likely to increase in value or appreciate over time due to rising home values across the United States.
Investing in your home and building equity now can ensure you have access to significant cash when you need it most. Let a Home Equity Specialist help develop a plan that works for your situation. Get started today!
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