What Is Home Equity and Why Is it Good to Have?

Published on April 3, 2019

Categories: Economics 101, Home Ownership | Tags: Debt, Home Equity, Wealth

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You hear a lot about the importance of equity as a potential homeowner. But what is equity, exactly? Well, put simply, home equity is the difference between how much your house can sell for and how much you owe on your mortgage(s).

And unlike when you’re a renter and your rent check only gets you some rooms for your stuff and maybe your water and garbage paid for, your continued mortgage payments increase that difference—your equity—every month.

It’s true that when you’re in the first years of paying off your mortgage, the gap only widens a bit, but as the years go by it not only gets wider but does so faster every month. Which mean you gain more equity in time.

Ways to Earn Equity

But here’s where it gets even better. You don’t just earn equity by making monthly payments; there are three additional ways to increase equity.

The first way is paying more than just your monthly payment. You can do this by simply over-paying every month or by switching to a bi-weekly schedule. A bi-weekly schedule cuts your payment in half, but because there are more than 28 days in a month—February excepted three years out of four—you end up paying an extra installment every year. Not a lot of money, but it adds up after 5, 10, or more years.

The second way to increase your equity is to make improvements to your home. Obvious efforts here would be an upgraded bathroom or kitchen, but even just sprucing up the front yard and applying a fresh coat of paint can add value—equity again—to your home.

There are limits, though, to how much of a return on investment you’ll get from these improvements, so you’ll want to speak with a Realtor or home improvement specialist to make sure your efforts will bring their maximum payback.

The third way you earn equity is through the normal increase in home property values for your neighborhood or city. As your home increases in value along with everyone else’s, your amount of equity rises accordingly.

As you’re no doubt aware, the last few years have seen record increases in demand, and consequently, home prices in many parts of the country.

What’s Equity Good For?

You don’t have to wait to sell your house to benefit from any accrued equity you have in your home. Here are four ways you can benefit from it today.

  1. Lower your mortgage rate. Generally, the more money you can put towards your down payment, the more equity you’ll have in your home to start with, and the lower your rate will be.
  2. Home Equity Loan or Home Equity Line of Credit (HELOC). If you need to finance some home repairs or help pay for a child’s college tuition, your equity is an asset you can borrow against.
  3. If you’re looking to acquire a second home or start investing in real estate, you can use the equity in your home to help finance your purchase.
  4. Reverse mortgage. If you’ve decided to retire, you can use your equity to provide you income without having to make payments. The reverse mortgage gets repaid when you leave the property (assuming the property holds its value.)

And as a bonus, if you own and live in your house for two of the five years before you sell it, the first $250,000 of profit is tax-free.

Not the Last Word on Equity

Owning a home isn’t part of The American Dream just because people really want an attached garage and a place to stick their garden gnomes. Home equity has helped millions of homeowners achieve financial independence and peace of mind.

Want to learn more about home equity and how you can put it to use? Answer a few questions here, and a home lending expert will contact you.