Home equity is the current market value of your home minus the amount you owe on it. Or even more simply, it’s the amount of your house you actually own. The more home equity you have, the more it can work to your advantage. Understanding what impacts home equity and how it works over time can be helpful in making financial decisions.
How Home Equity Works
The equity in your home usually grows over time as you pay down the principal on your mortgage and the housing market changes.
For example, say you purchased a house for $250,000 with a down payment of $75,000. At the time of purchase, you had $75,000 equity in the home, and your lender had $175,000. But over the next 20 years, you paid down your mortgage, and the housing market grew so that the house you paid $250,000 for was now worth $500,000. If you’ve paid off your original mortgage and not taken another, your equity in the house is now $500,000.
The example above is simple and assumes the buyer had a single mortgage over twenty years. But in the real world, home equity tends to go up and down over time as people refinance or take out second mortgages and market conditions fluctuate. The important thing to understand is that home equity isn’t a constant or a guaranteed figure but is dependent on other factors, some of which homeowners can control and some of which they can’t.
If you want a general idea of how much equity is in your home, you can use an online home equity calculator. Checking your address on online real estate platforms will give you a ballpark estimate for your home’s current value. For a more specific calculation, an appraisal will offer a concrete analysis of the current market value of your home.
How to Increase Home Equity
You increase your home equity every time you pay down the principal on your mortgage. The principal is the amount of money you owe on the home. A typical monthly payment on a mortgage includes four types of payments: principal, interest, insurance, and property taxes. The amount you pay toward interest, insurance, and taxes does not affect the amount of equity you have in the home. You will need to subtract the portions of your monthly mortgage payment that go to interest, taxes, and insurance before calculating how much equity you gain with each mortgage payment. Your mortgage statement will show how your payments are allocated.
Generally, in the early years of a mortgage, you will pay more interest, while toward the end, more funds will be applied to the principal. You can grow your equity faster by making extra mortgage payments, a large down payment, or paying off your loan before the end of the loan term.
Market fluctuations also increase home equity. If the market is favorable, the value of your home is likely to increase. This is good news since the amount you owe on the loan stays constant as the value of your home appreciates. In addition to the housing market, keeping your property in good condition and making improvements can increase its value (and your equity).
Just as a home can increase in value, it can also decrease. Adverse market conditions can result in sinking home sale prices and values. Just as improving your property can benefit you, letting it fall into disrepair can negatively affect your equity.
How Can Homeowners Access Equity?
Home equity is a little like having money in a safety deposit box. You own it, but accessing it takes some effort. The most straightforward way to turn your home equity into cash is to sell your home, but then you’ll probably need to use at least some of that to pay for a new place to live.
There are multiple ways to access equity in your home without selling it. Often loans based on your equity have lower interest rates than personal loans or other forms of financing. Loan types designed specifically to tap equity include:
- Cash-out refinance
- Home equity loan
- Reverse mortgage (for borrowers over 62)
- Home equity line of credit (HELOC)
- Shared equity agreement
Before choosing any financial vehicle, it’s always a good idea to consult a financial professional who can help you fully understand your options and advise which would be most advantageous for your situation.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.