What Is Home Equity [Plus The 9 Best Ways to Leverage It] (2024)

Simply put, home equity is the amount of your home that you actually own. It’s the difference between what you owe on your mortgage and what your home is currently worth. For example, if your home is currently worth $500,000 and you owe a remaining $400,000 on your mortgage loan, your home equity would be $100,000.

That figure can rise and fall until the mortgage is fully paid and you own your home outright. The primary way to raise equity is by paying down your mortgage’s principal balance (that is, the amount you borrowed and have to pay back). Your home equity can also fall if your home’s value decreases at a faster rate than you are paying down your mortgage. Once you’ve paid off your mortgage, you own your home outright.Citation

With the recent housing market surge, your home equity is likely rising, meaning now could be the perfect time to leverage your home equity.Citation But, first, it’s important to understand how your home equity works.

With the goal of paying down your mortgage to leverage the most equity, it’s important to understand the four components that make up each mortgage payment:

• Principal: The amount of money you borrow from a lender
• Interest: A percentage of your mortgage that is paid to the financial institution that approved your loan
• Taxes: Determined annually by local and state officials in order to maintain public resources, like schools, roads and first responder services
• Insurance: A good idea to cover your physical building structure and belongings inside incase of fire, flood or other damage. If you put less than 20% down during a home sale, your lender may require additional coverage called private mortgage insurance, or PMI, to cover any lost payments.

Now for a few quick examples to help you better understand how home equity works.

Imagine you buy your home for $500,000 with a 10% down payment; this means your mortgage loan is $450,000, and that you have $50,000 worth of equity you can tap into.

Now, fast forward one year. Imagine your home’s value increases by $50,000 to $550,000, and that you’ve paid an additional $20,000 on your mortgage, leaving $430,000 remaining on the principal balance. Based on these figures, your home equity would now be $120,000.

The opposite also applies— if your home’s value were to decrease, it could negatively affect your equity. For example, if you’ve paid your mortgage down to $430,000, but your home’s value decreased to $450,000, your equity would now be $20,000.

To determine your home equity, you need to know your home’s current value. You can receive an official evaluation of your home from a real estate appraiser, or an informal estimate by looking at comparable home sales in your area (but not that this is not always accurate).

Here are seven smart ways to build home equity and achieve your financials goals:

1. Make a Larger Down Payment
   The fastest and most reliable way to build home equity is to make a large down payment when you purchase your home. The larger your down payment, the more home equity you’ll have, right off the bat. Making a large down payment will not only increase your equity, but will also reduce the amount of money you need to borrow.It’s pretty straightforward: Let’s say you were to buy a home for $300,000 with a down payment of $10,000; this would leave you with a remaining balance of $290,000 on your mortgage and $10,000 worth of equity. If, however, you were to increase your down payment to $20,000, the remaining balance on your mortgage would be $280,000, and your home equity would be $20,000.
2. Continue to Pay off Your Mortgage Over Time
   To build home equity — and to avoid any potential repercussions — it’s important that you make every mortgage payment on time. Making consistent monthly payments not only reduces your principal balance, but also what you owe in interest and property taxes.
3. Pay a Higher Amount Than Your Minimum Monthly Payment
   A great way to build more equity in less time is to pay more than your minimum mortgage payment. You can do this by making additional payments each year, setting up bi-weekly rather than monthly payments or paying extra each month.
4. Increase the Value of Your Home
   You can increase the value of your home — and your home equity — through renovations. Some of the highest value renovations include remodeling your kitchen, adding a bathroom or replacing exterior siding. Before starting any renovation, make sure you understand financing options available to you, and do your research because there are certain renovations that can actually lower your home’s value.
5. Refinance to a Shorter Loan Term
   Another potential way to build home equity is to reduce the term of your loan through refinancing. Shorter loan terms typically come with lower interest rates and increase the amount of money from your monthly mortgage payment that goes toward your principal balance. It’s important to note, though, that reducing the term of your loan will require you to make higher payments each month; make sure you can afford this payment increase before refinancing.
6. Stay in Your Home for at Least Five Years
   The longer you live in your home, the more home equity you’ll build. Your home’s value could increase over time — especially if you make value adding renovations — increasing your equity. Even if your home’s value doesn’t increase over time, consistently paying down your principal balance will add to your home equity.
7. Avoid Paying PMI
   PMI is a form of insurance lenders require for conventional loans to protect themselves in the event that a homeowner defaults on their loan. PMI increases your monthly mortgage payment without contributing to equity, so it’s in your best interest to either avoid it entirely or remove it from your loan. The easiest way to do this is by paying at least 20% down when purchasing home, but current homeowners can also eliminate PMI by paying down the loan’s principal balance to 80% or lower of the home’s original appraised value, or to 80% of the home’s current market value.Citation

There are a wide variety of ways for you to leverage your home’s equity — here are some of the best ways to make your money work for you:

1. Buy a New Home
   If you’ve lived in your home for a few years and are considering a move, you can leverage your home equity to help fund your next home purchase.Here’s how: Let’s say your home is worth $600,000, and you’ve built $100,000 in equity. While you may not receive that entire $100,000 due to fees, such as realtor’s commission or closing costs, you’ll likely walk away from the sale with a substantial amount of money that you can then use to make a down payment on your next home. And by making a larger down payment on your next home, you’ll be able to lower your monthly mortgage payments and interest paid over time and increase your home equity.
2. Increase Retirement Savings
   Homeowners aged 62 and older can leverage their home equity to fund their retirement savings using a reverse mortgage, such as Home Equity Conversion Mortgage.Citation Using your home equity to increase your retirement savings can be a smart way to grow your wealth and secure your financial future by diversifying your portfolio and mitigating your risk of fluctuations in the market.Citation As with any major financial decision, be sure to do your research and consult a qualified loan officer before pursuing this option.
3. Invest in Home Improvements
   Want to remodel your home, but don’t have the cash on hand for renovations? Consider using your equity. You can leverage your home’s equity to make improvements to your property, which not only helps you save on remodeling costs but can also increase your home’s value over time, increasing your equity and potential profits should you eventually choose to sell.
4. Consolidate High-interest Debts
   A home equity loan, home equity line of credit (HELOC) or cash-out refinance can be a smart way for homeowners to consolidate debt, often at a lower interest rate. For example, credit cards typically carry interest rates between 15% and 25%, while the average home equity loan and HELOC interest rates currently sit below 10%.CitationCitation In addition to being a good way to lower interest rates, consolidating debt through refinancing reduces the number of monthly payments you need to keep track of, can increase your potential tax deductions and can improve your credit score.
5. Eliminate PMI
   You can leverage your home equity to break free from PMI. By refinancing, you have the opportunity to secure a new loan with better interest and/or lower monthly payments.
6. Cover Higher Education Costs
   Whether you’re saving for your child’s future, your kids are currently in college or you’re looking to pay off your own student debts, you can leverage your home equity to cover higher education costs. Refinancing can help reduce your interest rates and leave you with more cash on hand to pay for tuition or pay off student debt.
7. Invest in Real Estate
   Investing real estate can be a great way to earn passive income and diversify your portfolio, but it generally requires considerable resources.Citation The good news is that homeowners can leverage their home equity to fund investment property purchases, making it easier for them to achieve their financial goals.

   Considering an Investment Property? Read This, First >>

8. Pay for Medical Expenses
   Many homeowners choose to leverage their home equity to pay off medical bills because home equity loans typically have lower interest rates and lower monthly payments than credit cards.
9. Create an Emergency Fund
   The general wisdom is that you should have three to six months-worth of living expenses in your emergency fund at any given time.Citation Using your home equity to set aside extra money in case of emergency is a good way to protect yourself for the future.

Leveraging your home’s equity can be a fantastic way to achieve your financial goals; however, there are certain uses that can set you back in the long run. To protect yourself from potentially negative repercussions, avoid using your home equity for the following:

• Vacations
  A lavish vacation can be exciting and relaxing, but not if it means having to pay higher monthly bills for years to come. Plus, if you can’t afford these increased monthly payments or consistently make them on time, you could risk damaging your credit score or even foreclosure.

• Everyday Expenses
  Similar to paying for a vacation, using your home equity to cover day-to-day expenses such as groceries, gas or social outings might provide immediate relief, but can cause problems for you further down the road in the form of higher monthly payments.
• Weddings and Other Special Events
  Between venues, catering, entertainment and more, the average wedding costs $30,000 — a substantial chunk of change.Citation While it can be tempting to use your home equity to fund a wedding or other special event, the long-term costs simply aren’t worth a single day of fun and can increase your risk exposure.
  
• Depreciating Assets
  Your home is an appreciating asset, meaning it increases in value the longer you own it; the same is true for real estate, which is why purchasing an investment property can be a smart way to leverage your home equity. Other assets, such as automobiles, furniture, electronics and machinery are considered depreciating assets and should be avoided at all costs.

Here are the four most common ways to access your home equity:

• Home Equity Loans
  A home equity loan works as a second mortgage on your home and, therefore, requires a second payment. Home equity loans tend to have higher interest rates than your initial mortgage, though these are still lower than interest rates for credit cards and personal loans. After getting approved for a home equity loan, you’ll receive a lump sum payment from your lender and will make payments (with interest) against this loan over a set term of five to 30 years.

• HELOCs
  Similar to a home equity loan, a HELOC is a second mortgage on your home; however, the difference is that a HELOC is more similar to a credit card in that it is a line of credit tied to your home’s equity. For example, if you have $50,000 of home equity, you could qualify for a HELOC with a max spending limit of $40,000. This means you could borrow up to $40,000, but not the full $50,000.With HELOCs, you only pay back what you spend, plus monthly interest and your credit line can be reused each month. It’s important to note, though, that HELOCs typically come with variable interest rates that fluctuate over time rather than a fixed rate. As a result, a HELOC can put you at risk of overspending, placing you deeper in debt and increasing your risk of foreclosure.Citation
• Reverse Mortgage
  Generally available to homeowners aged 62 and older, reverse mortgages can be a great way for seniors to access their home equity and reduce their retirement savings. Compared to other options, reverse mortgages do not require monthly mortgage payments; instead, homeowners pay property taxes and insurance, and the debt is paid after the homeowner is no longer living in the home.The loan balance for a reverse mortgage is based on your total home equity. If you have an existing mortgage to pay off, the proceeds of a reverse mortgage must be used to pay off your first mortgage before you can access the remaining balance. There are a few ways to access your equity using a reverse mortgage, including receiving monthly payments for as long as you live in your home, monthly payments over a fixed period or a line of credit that you can use at any time.
• Cash-out Refinancing
  Compared to other options, cash-out refinancing enables you to take out your home equity by applying for a new mortgage at a higher loan amount. In other words, you replace your existing mortgage with a higher value one and receive the difference in cash. For example, if you owe $200,000 on your mortgage, you could refinance for $250,000 and pocket the additional $50,000 (in cash). You would then make payments on that second, $250,000 mortgage in monthly installments, including interest.How much extra money you can apply for with a cash-out refinance depends entirely on your home’s equity. Any money you receive from a cash-out refinance comes with no restrictions and is tax-free.Cash-out refinancing is a popular option for a few reasons:
  • Homeowners have access to larger amounts of cash, which they can spend however they choose (though, as noted earlier, certain investments are more wise than others).
  • Homeowners who use their cash-out refinancing funds to make improvements to their home could be eligible for certain tax deductions. Using cash-out refinancing funds for renovations can also build equity in the long run.
  • Cash-out refinances are typically fixed-rate mortgages, which means there are no surprise fees, so it’s easier to manage your monthly payments.

Looking to refinance? The Blue Water Mortgage team is here to help >>

Q: What is home equity?
A: Home equity is how much of your home you actually own. It’s the difference between what you owe on your mortgage and what your home is currently worth.

Q: How can I best leverage my home equity?
A: Here are some smart ways to leverage your home equity:

• Buying a new home
• Adding to your retirement fund
• Making home improvements
• Consolidating high-interest debts
• Removing PMI
• Paying for higher education
• Real estate investing
• Paying off medical expenses
• Protecting yourself with emergency funds

Q: How can I access my home equity through cash-out refinancing?
A: You can access your home equity through cash-out refinancing by simply replacing your existing mortgage loan with a new one. Some of the benefits of cash-out refinancing include access to a large amount of cash, lower interest rates, predictable payments, an increase in your home’s value and potential tax deductions.

If you’d like to access your home equity through cash-out refinancing, talk to the mortgage experts at Blue Water Mortgage today.

Q: How can I quickly build home equity?

A: Your home equity builds when you pay off your mortgage or when your home increases in value. To build equity faster, consider doing the following:

• Making a larger down payment
• Paying off your mortgage
• Paying more than the minimum amount for your monthly mortgage payment
• Increasing the value of your home with renovations
• Refinancing to a shorter loan term
• Staying in your home for 5+ years
• Making a larger down payment to avoid private mortgage insurance

Roger is an owner and licensed Loan Officer at Blue Water Mortgage. He graduated from the University of New Hampshire’s Whittemore School of Business and has been a leader in the mortgage industry for over 20 years. Roger has personally originated over 2500 residential loans and is considered to be in the top 1% of NH Loan Officers by leading national lender United Wholesale Mortgage.