Here’s How To Build Equity in Your Home
The amount of available equity you have in your home can play an essential role in your financial life. Home equity is the difference between the value of your home and your current mortgage balance. For many homeowners, the equity they’ve built up in their home is their largest financial asset. It’s a crucial part of building wealth.
More American homeowners may be feeling equity-rich these days. According to the latest numbers from the Federal Reserve Bank of St. Louis, in the fourth quarter of 2017, average home equity surpassed its pre-recession peak of $13,431.94, reaching a new high of $14,416.75.
Let’s take a look at what can homeowners do with that equity and what you can do to build equity in your home.
- The power of increasing your home equity
- You may be able to eliminate PMI
- More financing options available
- Financial cushion
- Increased net worth
- How to build equity in your home
- Rising home values
- Paying more on monthly mortgage payments
- Home improvements that add value
The power of increasing your home equity
Having equity in your home isn’t just about the good feelings that come with knowing your home is worth more than you owe on your mortgage. There are serious, tangible benefits, including:
You may be able to eliminate PMI
Most lenders charge private mortgage insurance (PMI) when a borrower makes less than a 20% down payment, but you may be able to remove PMI once the principal balance of your mortgage reaches 80% of the original value of your home.
More financing options available
Many homeowners borrow against their home’s equity to finance repairs and upgrades, pay for education and pay off high-interest credit card debt. If you’re interested in taking out a home equity loan or line of credit, your home equity is one of the factors a lender considers when deciding whether or not to approve your application and how much it will cost you to borrow money.
Many older Americans view their home as a sort of retirement asset. When you have significant equity in your home, that equity can act as a financial cushion against unexpected events. If you face financial hardship, you may be able to access your home’s equity with a home equity loan or line of credit or sell the property to cover long-term care needs.
Increased net worth
The more equity you have in your home, the greater your net worth. Your personal net worth is the difference between the value of what you own (your assets) and what you owe (your debts). Knowing your net worth can be a good way to understand your financial situation and measure progress toward your goals.
How to build equity in your home
Rising home values
One method for building equity in your home may require no effort on your part at all. When real estate values in your area rise, you gain equity in your home. And historically, that’s accounted for pretty significant gains for many homeowners.
The National Association of Realtors reported that in the fourth quarter of 2017, the median existing single-family home price in the U.S. was $247,800, up 5.3% from the fourth quarter of 2016. On a house valued at $250,000, that accounts for an increase in equity of $13,250 in just one year.
Keep in mind, though, that a property’s value doesn’t always increase. Whether or not your home’s value increases depends on a number of factors, including supply and demand and the overall economy. For instance, in the years following the 2008 recession, many homes saw a significant decrease in value.
How can you know what your home is worth? When you prepare to sell your home, your real estate agent will typically help you come up with a value to set the sales price. But even if you have no intention of selling right now, there are several ways to find out the current value of your home.
Online home value calculators, which use data from the MLS (the database that real estate agents use to list properties) and public records to estimate your home’s current market value.
But keep in mind those are just estimates, and they only take into account available information. The actual value of your home depends upon many factors, including the condition of your home. These calculators may not know that you recently remodeled your kitchen and bathrooms or that it still has the original 1970s green shag carpet.
Look at recently sold homes
Homes in your neighborhood that have recently sold provide better insight into actual market conditions. If homes similar to yours in your general area recently sold, check out the sales price online. They’ll usually list the recent selling price and include details such as square footage, features and maybe even pictures. If a home is similar in size and condition to yours and it sold within the last few months, the sales price should give you a general idea of what your home would sell for.
The most accurate way to determine your home’s value is to get a professional appraisal. According to Bank of America’s Better Money Habits, an appraiser will calculate your home’s value by considering:
- Comparable properties that have sold recently
- General condition and age of the home
- Size and features, including the number of bedrooms and bathrooms
- Major structural improvements
- Features and amenities
But a professional appraisal costs money. An appraisal typically costs around $300 to $400, but it varies based on the size and location of your home, among other factors. For that reason, homeowners typically only pay for an appraisal when they are selling, refinancing or applying for a home equity loan or line of credit.
Paying more on monthly mortgage payments
A good way to increase the equity in your home is to pay down your mortgage. Each month when you make a mortgage payment, a portion of your payment goes toward interest, part of it may go toward real estate taxes and homeowners insurance and the remainder goes toward paying off your mortgage’s principal balance.
The faster you pay down that principal balance, the quicker you can build equity in your home – assuming the value of your home stays the same or increases.
For instance, say you have a $300,000, 30-year fixed mortgage with a 4.5% interest rate starting in March 2018. Let’s look at the difference in what you’ll pay in interest and how fast you can pay the mortgage off if you paid an extra $500 per month toward the principal balance on the loan.
|Monthly Mortgage Payments|
|Standard Repayment Schedule||Extra $500/Month Principal Payment|
|Total Interest Paid||$247,220.25||$139,306.31|
|Final Payment||March 2048||April 2036|
By paying an extra $500 per month toward the loan’s principal, you would save over $107,000 in interest payments and pay off your mortgage 143 months (nearly 12 years) faster.
However, keep in mind that paying off your mortgage early sometimes results in a prepayment penalty. A prepayment penalty typically only applies if you pay off your mortgage within a specific number of years – usually three to five years, according to the Consumer Financial Protection Bureau (CFPB). If your mortgage has a prepayment penalty, it will be included in the disclosures you signed when you bought the home, so be sure to read the fine print carefully.
If you plan on making additional principal payments on your mortgage, make sure you tell your lender that you want the extra payments to go towards the principal. Otherwise, your lender may simply apply the extra money to next month’s payment.
Home improvements that add value
Another way to build equity in your home may be to make improvements. But proceed with caution. While some improvements can positively affect your appraisal, it’s a good idea to consult a real estate professional before investing in home improvements simply to raise your home’s value.
Sep Niakan, a broker with HB Roswell Realty in Miami, says basic improvements, such as painting and updated light fixtures typically go a long way toward improving your home’s value when it’s time to sell.
“But why wait until you are ready to sell your home to do these things?” Niakan asked. “If you have good upkeep on the basics, you’ll have a home you can enjoy while you are living there, not just for prospective buyers.”
He also recommends investing in high-quality improvements that will keep your home looking modern.
“Many people believe that doing key updates on a home don’t go a long way and are risky because prospective buyers may not like your taste,” Niakan said. “But I don’t believe in that philosophy. Doing things like replacing flooring to commonly accepted flooring types and color make your home stand out and attract the kind of borrower that wants a high-quality, finished product and are willing to pay for a move-in ready property.”
Remodeling magazine releases an annual Cost vs. Value Report to compare the average cost for several popular remodeling projects with the value those projects retain when the property is sold. While the resale value of most projects varies by location, for 2018, the projects that recoup the most costs are:
|Home Imrpovement Costs vs Resale Value|
|Project||Job Cost||Resale Value||Cost Recouped|
|Garage Door Replacement||$3,470||$3,411||98.3%|
|Manufactured Stone Veneer||$8,221||$7,986||97.1%|
|Entry Door Replacement (steel)||$1,471||$1,344||91.3%|
|Deck Addition (wood)||$10,950||$9,065||82.8%|
|Minor Kitchen Remodel||$21,198||$17,193||81.1%|
If you watch a lot of home improvement TV shows, those numbers may surprise you. Those shows often make it look as though spending $1,000 on paint and new lighting fixtures translate into an almost guaranteed $2,000 increase in the value of your home. But building equity through home improvements isn’t that straightforward in the real world.
Brian Davis, a real estate investor and co-founder of SparkRental, says “most home improvements have a negative return on investment, but that doesn’t mean they’ll reduce your home’s value – it just means that they cost more than the equity they create.”
Davis recommends a few improvements that can be an exception to that rule:
- Outdoor living updates. “People love their decks and patios,” Davis said. “If your property doesn’t have an outdoor living space, consider adding one. If it does have one, look for ways to spruce it up and make it more appealing. That can be as simple as adding a few potted plants or as involved as adding a small fountain.”
- Smart home updates. “Most smart home updates cost between $100 and $300, and just adding a few will let you market your property as a “smart home.” A smart thermostat is a great place to start, costing around $200-$250 and generally saving $120-$150 per year in energy,” Davis said.
- Energy-efficient updates. “Similarly, any updates that homeowners can use to mathematically demonstrate lower energy bills will boost the property’s value,” Davis said. “Examples include new fiberglass insulation, energy-efficient windows, Energy Star appliances and more.”
But some improvements can actually negatively impact your property value. Evan Roberts, a real estate agent with Dependable Homebuyers in Baltimore, says one that comes to mind is when a homeowner converts a three-bedroom home into a two-bedroom home. “This is often done to expand the master bedroom into a suite with walk-in closets,” Roberts said. “While this may have been the optimal payout for the homeowner, it reduces the usability of the home for most homebuyers, which is a family with two or three children.”
Your home is likely to be your biggest asset, so the more equity you have, the more options you’ll have when it comes time to refinance or sell it. You don’t have to sit around and wait for your home to increase in value on its own. You can pay more toward your principal and plan smart improvement projects to build equity sooner rather than later.