Home Equity provides a safety net, frees you up from private mortgage insurance (PMI), and moves you further away from mortgage debt the higher you grow it. Building home equity can inch you closer to your financial goals. And the best part? You can take an active role in that growth of property value.
Understanding how to build equity in a home starts with defining home equity and identifying the five key ways to build it.
What is Home Equity?
First things first, what does home equity mean? Very few people show up with a garbage bag full of cash to close on a home purchase. Mortgage loans allow us to buy property and pay it off over time instead of saving up for decades to afford our own castles.
Equity refers to the fully owned value of your property at a given point in time. It’s a little more complex than whether you or a bank owns your home. Here are the terms you need to know:
- Appreciation – Over time, most real estate increases in value, meaning your home is generally worth more than what you (and a lender) originally paid for it.
- Mortgage payments – As you pay down the principal on your mortgage loan, the ownership balance changes, so over time you own more of it, and the lender owns less.
To calculate your equity related to both factors, subtract the amount you still owe on your mortgage from its current market value.
5 Ways to Build Equity in a Home
Here’s the good news: you’re already building your home equity simply by making monthly mortgage payments and letting time do its work. But the even better news is that you can speed up equity growth by following these five tips.
#1 Boost Your Down Payment
A down payment is the first building block of home equity. As of early 2023, the average down payment in the U.S. was 13%.1
If you can make a 20% down payment, you’ll start off with 20% home equity in your property. Plus, you’ll be able to avoid PMI, which will save you from paying an extra 0.58% to 1.86% of the original mortgage loan amount per year.2 A higher down payment also means a lower monthly mortgage payment.
#2 Choose the Right Home Improvements
One of the best ways to increase equity and property value as homeowners is through improvements and renovations. Since equity is calculated by subtracting the amount you owe on your mortgage from your current home value, you can grow it by increasing the latter. When it comes to home improvement projects, you can add value to your equity if you choose projects that benefit your family, reflect your taste, and increase your home’s appeal.
Here are examples of upgrades and home improvements that allow you to recoup between 85.7% to 103.5% of your remodeling cost:3
- HVAC conversion to electric
- Garage door replacement
- Manufactured stone veneer
- Steel entry door replacement
- Vinyl or fiber-cement siding replacement
- Minor, mid-range kitchen remodel
#3 Pay Down Your Principal
As homeowners, you already know the monthly payment is building equity over time. But In addition to your regular monthly payments, talk to your mortgage lender about making principal-only payments. If you’re up to date on your mortgage and don’t have outstanding fees, most lenders will allow you to pay down your principal directly. These grow equity faster than a regular monthly mortgage payment that’s split between principal, interest, taxes, and insurance.
#4 Switch to Biweekly Payments
Another way to add equity is to pay off your home loan balance as quickly as possible. If you can swing biweekly payments instead of one monthly payment, it’ll equal 13 full mortgage payments instead of 12 each year—another option to grow equity and pay off your mortgage more quickly.
This could mean a shorter loan term and a lower mortgage payment without refinancing in the future. It might be a bit of a change if you’re used to budgeting for the month, but biweekly payments could allow you to pay off a 30-year mortgage balance in as little as 22 years.4
#5 Don’t Borrow Against It
A home equity loan (or the process of borrowing against your home equity) is a bit like a time machine. Rather than moving forward toward paying off your mortgage balance, you’re moving backward. As a result, your home equity decreases, rather than increases.
If you sold your property after a home equity loan, then you’d have to pay off your original mortgage plus the home equity loan, and your equity would be revealed in the remaining profit.
The Role of Sale-Leasebacks
Once you’ve built your home equity up, did you know there’s a way to unlock your total equity without moving out and finding a new place to rest your head?
Sale-leaseback programs combine a property sale with a lease agreement and guarantee that you can stay in your home as long as you’d like as a renter. In a sales-leaseback, you’ll have:
- A pre-negotiated, locked-in lease rate for a period of years plus limits on future increases
- Freedom from property tax and homeowner’s insurance costs
- A building manager who covers the hassle and cost of covered repairs and maintenance
Building Equity for Long-Term Wealth: Key Takeaways
Your home equity can provide financial security and an investment in your future.
Rather than relying solely on time plus monthly mortgage payments, you can build your equity through a larger down payment, high-return property improvements, paying down the principal, making biweekly payments, and not borrowing against it.
If you’re ready to turn equity into cash without moving or taking on new debt, consider a sale-leaseback.
Sources:
- Realtor.com. Down Payments Fall From Recent Peak. https://www.realtor.com/research/down-payment-report-2023
- Urban Institute. Mortgage Insurance Data At A Glance – 2021. https://www.urban.org/sites/default/files/publication/104503/mortgage-insurance-data-at-a-glance-2021.pdf
- Remodeling. 2023 Cost vs. Value Report. https://www.remodeling.hw.net/cost-vs-value/2023/
- Rocket Mortgage. 8 Tips For Building Equity In A Home. https://www.rocketmortgage.com/learn/building-equity
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