Building equity in your home can take time, but the more equity you have, the more money you can borrow against it to tackle major expenses. Homeowners tap into their home equity when they need funds for such life events as paying for college tuition, home renovations or to pay off high-interest consumer debt like credit card debt.
Mortgage lenders prefer that you have at least 15% to 20% of equity built up in your home before they’ll let you borrow against it. For the average homeowner, it can take about five to 10 years to build that amount of equity.
Read on to learn more about the ways you can start building more home equity right now.
What is home equity?
Home equity is simply the difference between what you still owe on your mortgage and the current market value of your home.
The way you calculate home equity is simple: Subtract your remaining mortgage balance from the market value of your home. If, for example, you took out a $450,000 mortgage and you still have $200,000 left to pay off, you have $250,000 of equity. Building up 15% to 20% equity can take upwards of 10 years for a typical homeowner with a 30-year mortgage.
5 ways to build home equity
The way to build your home equity is by making consistent mortgage payments over the years. The longer you pay off your mortgage, the more equity you’ll have in your home.
1. Make a down payment
Making a large down payment is one of the easiest and fastest ways to build up equity in your home. The more you put down when you purchase the home, the more equity you have from the beginning. Plus, if you make a down payment of 20% or more, you can eliminate the requirement for private mortgage insurance, or PMI, which can add hundreds of dollars to your monthly mortgage payment.
2. Focus on paying off your mortgage
You can always make an additional mortgage payment or two if your budget allows. Making 13 or 14 mortgage payments a year instead of just 12 will cut down the amount of interest you pay over the lifetime of your loan, as well as shaving off the amount of time it takes you to pay back the loan. If, for example, you get a tax return this year, consider putting that chunk of money towards your mortgage instead of towards savings or investing -- if you can afford it.
3. Pay more than the minimum
Just as with credit cards, you’ll pay off your debt faster if you pay more than the minimum payment due every month. The same is true for mortgages. If you can pay $100 or $200 more towards your home loan each month, you’ll reduce the amount of interest you pay over time on your mortgage. Plus, as with most mortgages, when you make a payment only a portion of it goes towards paying off the principal balance of your loan -- your payment also goes towards paying down the interest or such items as PMI. Take the time to understand the terms of your mortgage and how your money will be used to pay back your loan to your lender.
4. Stay in your home at least five years
For most homeowners, it takes around five to 10 years to build up 15% to 20% of home equity. So if you plan to move before five years, it may not make sense to try and tap into your home equity because you may not have established enough yet. Home values also tend to rise over time, so if you don’t stay for at least five years you can’t take advantage of the appreciation of the value of your home, which naturally gives you more equity in your property.
5. Renovate and spruce up
Home renovations are a great way to use your home equity because you increase the value of your home while enjoying your investment. Plus, there are tax benefits if you access your home equity using certain types of home equity loans. For example, if you use a home equity line of credit, or HELOC, to complete any home improvements, the interest on your loan is tax deductible.
The bottom line
Building your home equity is important because it provides you access to cash, often at low interest rates. Home equity loans are a reliable way to access funds without having to sell your home or use higher interest financing options such as personal loans. As long as you have at least 15% to 20% equity accrued in your home, most mortgage lenders will let you borrow up to 85% of the value of your home -- assuming you meet the rest of their requirements for aspects of your financial life like your credit score and your income.
Remember, when you borrow against your home equity it’s a secured loan: You’re using your home as collateral to secure your equity loan. That means that your bank or lender can repossess your home if you fail to make your payments. Make sure you can comfortably afford the monthly payment that comes with a home equity loan (often referred to as a second mortgage) on top of your first mortgage payment.
