Owning a home has many advantages. Homeownership includes tax benefits, provides stability for families, and homes are a significant investment. Homes also offer equity, which is a less understood benefit. What is equity and how does it help a homeowner?
What is home equity?
Home equity is the portion of your home that you own. If you paid a down payment of $40,000 and had paid another $100,000 in principal over ten years, you have $140,00 worth of equity in the home. Since your home will probably be the most significant investment you make in your life, this equity is the most valuable thing you have as an asset. The value you have can be used to purchase other items, get a line of credit, or upgrade your house.
How does home equity work?
To figure out the amount of equity you have in a home, it is a straightforward calculation. It is the current value of the home minus the amount of money you owe on loan. The value of your home will fluctuate with the market, but paying down your mortgage every month will increase the amount of equity you have.
How is home equity valuable?
Home equity is valuable in several ways. First, most lenders will require that you get mortgage insurance on any lender that doesn’t have 20% equity in their home. Once you reach the 20% threshold, you will no longer be required to pay this additional expense. Second, you can borrow money using your equity, as long as you meet specific requirements. Third, the more investment you have in your home, the more capital you will get from the sale of your home when that time comes.
How can you build equity faster?
Now that you know that equity in a home is valuable, are there ways to build it faster? There are several ways to do so.
- Use the equity you have to make home improvements. Not all home improvements are cost-effective, so look at ones that make financial sense. It is usually a sound investment to improve kitchens, bedrooms, and finishing basements. Talk to a real estate professional to find out if doing improvements are a good investment.
- Make extra payments. You can significantly reduce the amount of your loan by just paying one additional payment a year. Make sure you specify to your mortgage lender that you want the extra payment to go toward the principle and not the interest.
- Refinance for a shorter period. When you got your first monthly mortgage payment, you may have just been barely able to pay it. Over time, you might get enough money to pay more of it. If you feel you can pay the loan over a shorter period, you might be able to pay a smaller interest, which can save you thousands over an extended period. If you can afford it, and it makes sense financially, do it.
Equity can be your most valuable asset, but only if you understand how it can work for you. By knowing more about it, you can save yourself a lot of money or improve your financial situation.