Home Equity 101: What it is & How to Build it
The best way to create wealth through owning a home is by building your equity. Home equity is the percentage of your home that you own. Home equity is a cornerstone to wealth building; however, you want to make sure that you aren’t putting down more than you can afford. Another benefit to having home equity is that it is a liquid asset that you can access if you need extra cash.
How to Figure Out How Much Equity You Have
Equity is often the down payment that you put on the home; you can determine how much equity you have by calculating the percent amount that you put down on your home. For example, if you put down $22,500 on a $225,000 home, your down payment would have been 10% of the total purchase, meaning that you have 10% home equity.
A general industry standard is that first time home buyers usually put down 7%, whereas repeat buyers put down around 17%. This can be attributed to where the homeowners are in life and how much savings they have access too.
6 Ways to Build Your Equity
We recommend working with a lender to determine which of these six ways your home can create wealth. All options are great, but some require time, money or both!
- Let Your Home Appreciate
Many people choose to build their equity by letting their home appreciate. The problem is appreciation can take a long or a short amount of time, and the only determining factor is the market conditions. Home prices have been going up in recent years which has made appreciation a massive advantage for homeowners.
The old model was to save until you could afford to buy a home, but with the steady yearly increase in home prices waiting might not always be the best idea.
Lenders primarily focus on your monthly budget when they decide if you can afford a home. Lenders are often comfortable with having clients spending between 43-49% of your income on monthly bills. This is on the high side, and in fact, the average in 2019 for homeowners monthly spend was only 38%.
- Make a Larger Down Payment
This option is best discussed with a lender because you want to receive a reasonable rate and have a good understanding of the market before you do this. The biggest red flag for this option is if you are someone that is trying to save extra cash to put more down. By waiting, many lose the chance to build equity through appreciation.
- Use Financial Windfalls
We recommend this option to our clients because it’s the best way to use the extra money that you receive. Get in the habit of using cash gifts, bonuses, inheritances, etc. to pay down your mortgage—it’s the best way to use spare cash! If you pay in lump sums, many lenders will recalculate or ‘recast’ your payments based off the diminishing balance.
- Make Bi-Weekly Payments
By making payments every two weeks instead of once a month, you will have paid an extra payment (13 instead of 12). Choosing this method will allow you to build equity faster and shave several years off a long-term mortgage. If you are choosing this method make sure your lender isn’t charging you extra for processing semi-monthly payments.
- Cut Your Loan Term in Half
For some people, this is not an option because they will have higher monthly payments and for some, a more difficult time qualifying for a loan. However, if you can afford it and do qualify, we recommend taking out a 15-year mortgage instead of a 30 year. Cutting your mortgage time in half will allow you to build equity twice as fast.
- Make Home Improvements
Choosing to make significant improvements, like renovating a kitchen will add substantial value to the overall cost of your home. Before making any major decisions, we recommend meeting with a professional to ensure that the increased value of the home will outweigh the cost of the reno.
Now I Have Home Equity, But How Do I Use It?
The three basic ways to access your equity is through borrowing a Home Equity Line of Credit (HELOC), a home equity loan, or by cashing-out refinance. There are definitely pros and cons to each, and we recommend speaking to a lender or bank manager to find out which option is best for you.