How to build home equity and make it work for you
Your home is your castle, but it also can be turned into a liquid asset when you need money. You build equity in your home as you pay your mortgage down, and when you build enough equity, you can tap into that value for whatever you need.
Maybe it’s paying for college. Maybe you were saddled with an unexpected expense that will exceed your emergency fund. Maybe that once-in-a-lifetime trip is happening now, when you’re cash-strapped and you don’t want to put all that fun on a credit card.
Whatever your need, your home equity can be an excellent source of funds. In essence, you’re putting your money to work for you.
To determine how much equity you have, subtract the fair market value of your home by the outstanding balance on your mortgage. So if you have a $200,000 home and you owe $150,000 on your mortgage, you have $50,000 of equity.
There are different ways to build equity:
- You can do nothing. Home values often will increase on their own, especially in this current market where available housing stock is lower than demand. As the value of your home increases, so does your equity. For instance, Ohio’s average home values increased nearly 7 percent in 2018, making that $200,000 home in our example now worth $212,000 and increasing your equity to $62,000. In a down market, however, you could be left with negative equity, meaning you owe more than your house is worth. About 10 percent of homeowners nationwide are in this predicament.
- Pay down your mortgage quicker. If you pay more than your scheduled mortgage payment every month, you’re putting extra money toward your principal amount rather than interest, which increases your equity.
- Improve your home. Updating an outdated kitchen or bathroom can increase the value of your home and drive up your equity. Be sure to research which improvements are the best return on your investment so you can recoup most if not all the costs if you sell the house.
- Start with a larger down payment. The more money you pay up front for your home is instant equity.
- Pay your mortgage. Early on most of your payment goes toward interest, but over time that payment shifts toward principal and your equity grows.
To tap into your equity, banks generally look for a remaining loan that is between 80 and 85 percent of the home’s value, meaning you have built at least 15 to 20 percent equity. There can be exceptions to that, but they are rare.
When you’re ready to borrow against your equity, there are several ways to do it. Remember that in all instances, you’re putting your home up as collateral, and you could lose it if you fail to repay your obligations:
- Home Equity Line of Credit (HELOC) – You control when and how to access the money, what it’s used for and how much of the line of credit to use. Most HELOCs have a 10-year draw period and work like a credit card. You can use it up to the limit for which you are approved and make payments over time while accruing interest or pay it all off when you are ready. You only pay interest on the amount borrowed, not the whole line of credit. You also can keep it at a zero balance and use it only when an emergency arises. HELOCs carry a variable interest rate and an annual fee (our bank waives this fee the first year). A HELOC is an excellent choice if you have a great interest rate on your mortgage and don’t want to refinance it.
- Fixed-rate second mortgage – You receive a lump-sum payment at a fixed interest rate and term. This is a good choice when you have a specific use for the money and want the peace of mind knowing when the loan will be paid back. These loans often are attractive because they have lower interest rates than credit cards or personal loans.
- Cash-out refinance – You refinance into a new loan what you still owe on your mortgage and whatever amount of cash you want to use from the equity you’ve generated. This option often is used for home improvement projects.
If you’re curious about or ready to use your home equity, start by having a conversation with one of our knowledgeable bankers. He or she will take the time to understand your unique situation and offer suggestions on which home equity solution makes the most sense for you. Our main objective is to find the loan that fits your lifestyle and needs.