If you own a home and have been making mortgage payments, chances are you've already started building home equity. The ability to access home equity can give you more financing options if you wanted to make a big purchase, pay down debt or do some home renovations. Here's how to calculate how much equity you have and some tips to build more.
Home equity defined
Home equity refers to the value of the portion of a property that you actually own. It's your home's current value minus what you still owe on your mortgage.
You've probably heard that buying a home is an investment. That's because the equity you build in your home can help you make other financial decisions down the line. For example, if you decide to sell your home, you could use the equity you've accrued to move into a different home — or you could put that money in savings. You could also tap into your equity while still living in your house to fund other financial needs.
How to build home equity
Your home equity can increase in different ways:
Make a down payment: The more you can put down initially means the more home equity you immediately have.
Your home's value increases: If changes in the housing market cause your home's value to jump, your equity will increase as well. Typically, your home will appreciate over time — and you'll accumulate more equity.
Make home improvements or renovations: Projects like redoing your kitchen countertops or adding a wood deck could boost home value.
How to calculate equity in your home
To calculate home equity, take the value of your home and subtract your mortgage balance.
Here's an example: Your home is worth $300,000, and you made a 20% or $60,000 down payment. Then, you took out a $240,000 mortgage to cover the rest. After your down payment, you have 20% equity in your home.
After five years of making mortgage payments, you now owe $200,000 for your mortgage. If the value of your home hasn't changed, you'd have $100,000 or 30% equity in your home.
But say the value of your home has increased to $315,000. To calculate your equity, you subtract your remaining mortgage balance ($200,000) from the home's current value to find you have $115,000 of equity, which is 36.5% of the home's $315,000 value.
Tip: You can use ComeHome to quickly see an estimate of your home's value.
Borrowing from home equity
There are a few ways to access your equity.
When you elect for a cash-out refinance, you essentially replace your existing mortgage with a new loan for an amount that's more than what you owe. The difference in the two loans is returned to you in cash and the funds are tax free.
For example, say your home is worth $300,000 and you owe $180,000 on your mortgage. You can refinance that amount for $200,000 — and you'll receive the $20,000 difference as cash.
The perk of going the cash-out refinance route is that it could potentially provide you with a lower interest rate than when you bought your home. To qualify for a cash-out refinance, lenders usually require you to retain at least 20% equity in your home — meaning you can usually only pull out up to 80% of your home's equity.
Home equity loan
Also known as a second mortgage, a home equity loan is a one-time, lump-sum loan that you can use as you wish. You would work with your lender and likely pay it back in fixed monthly payments, typically over several years. Keep in mind, you still have to get approved for the loan and you would be using your home equity as collateral.
Home equity line of credit (HELOC)
A HELOC acts similarly to a credit card. As opposed to taking out a lump sum, HELOCs let you set up a line of credit that you can borrow from on an as-needed basis. These lines of credit often feature variable interest rates – meaning that the interest rate will fluctuate over time in response to market changes. The borrowed funds are typically repaid over the course of several years.
A reverse mortgage loan is an option for homeowners who are age 62 and older. Rather than making mortgage payments, borrowers pay only the property taxes and insurance each month. Interest and fees will be added to the loan monthly, and the loan needs to be repaid when the borrower no longer lives in the home.
Tip: It's important to keep in mind that with any of these methods, you can't always borrow against the full amount of your total amount of equity. And because your home acts as collateral, should you miss payments on your loan, your lender has the right to take your home via foreclosure.
Understand your assets
Tapping into your home's equity can be a financially savvy way to access funds, but remember that it's not free money and you will have to repay it, plus interest. As you make mortgage payments, don't forget about the valuable asset you're gaining by building up equity.