Market Analysis

Dreaming of the day you fully pay off your mortgage and eliminate those monthly payments is common. However, there are additional advantages to reducing your mortgage balance, with the primary benefit being the ability to build equity.

Home equity represents the portion of your home that you have paid off. You can access this equity as cash through options like a cash-out refinance or a second mortgage, allowing you to cover significant expenses. Moreover, your home equity can be a valuable resource for a down payment on a future property. Having less debt on your current home can simplify the process when you decide to sell and purchase another one.

Understanding how home equity works is essential for maximizing its potential and using it to your advantage.

What is Home Equity?
Home equity is the percentage of your mortgage that you own outright. To estimate your equity, subtract your remaining mortgage balance from your home's current market value. You can determine the market value by comparing similar homes in your area or hiring an appraiser for a precise valuation. Alternatively, for a conservative estimate, you could simply subtract your remaining balance from your original purchase price.

For example, if you bought a home for $500,000 and have $350,000 remaining on your mortgage, your equity calculation would look like this:

500,000−350,000=150,000
This means you have $150,000 in home equity, which constitutes 30% of your home's value (150,000 divided by 500,000 = 0.30, or 30%). Keep in mind that these figures can fluctuate based on changes in market value or significant improvements you make to the property.

Why is Building Home Equity Important?
Increasing your home equity is beneficial because it contributes to your overall wealth. The more equity you build, the greater your profit when selling the house. Additionally, the home can serve as a significant asset to pass down to future generations.

Equity also provides a safety net for covering substantial expenses. In the event of a financial emergency or unexpected medical bills, you can utilize a home equity loan or a home equity line of credit (HELOC) to access your equity. This approach often comes with lower interest rates compared to credit cards, making it a more economical choice.

Tips for Building Equity in Your Home
Building equity naturally occurs as you make regular mortgage payments. However, you can accelerate this process without significantly changing your budget by following these tips. The example used here is based on a $400,000 mortgage with a 30-year term and a 6% fixed interest rate.

Stay in Your Home Longer
Building equity takes time. Initially, a larger portion of your payment goes toward interest rather than principal. Over time, however, more of your payment will contribute to the principal balance. Staying in your home for several years allows you to pay down more principal and potentially benefit from appreciation in market value. For example, on a $400,000 mortgage at 6%, you would pay off over $27,000 in principal in the first five years.

Make Biweekly Payments
Switching to biweekly payments can expedite your loan repayment, allowing you to make two extra payments each year. With biweekly payments on a $400,000 loan at 6%, you could pay off your mortgage in just under 25 years, increasing your equity faster and reducing the time to pay off the loan.

Make Extra Payments When Possible
If you receive unexpected cash, such as a tax refund or bonus, consider applying it as an extra payment on your mortgage. Be sure to confirm with your lender that the extra payment will go toward the principal rather than interest, as only payments toward the principal will increase your equity.

Pay Extra Toward Your Principal Regularly
Adding even a small amount, like $10 or $20 per month, can shorten your mortgage term and boost your equity. For instance, contributing an extra $20 monthly on a $400,000 mortgage could increase your equity by nearly $1,400 in the first five years and reduce the loan term by about eight months.

Avoid Cash-Out Refinancing
While a cash-out refinance allows you to access your home equity, it involves taking out a larger loan, thereby reducing your overall equity. Although it may serve other financial needs, it's not an effective strategy for building equity.

Eliminate Private Mortgage Insurance (PMI)
If your initial down payment was less than 20%, you may be paying PMI. Once you achieve 20% equity, request your lender to remove it; at 22%, it should be automatically removed. Eliminating PMI means those funds can instead contribute directly to your mortgage payment, helping you build equity faster.

Choose Home Improvements Wisely
Certain renovations can enhance your property value. When considering improvements, evaluate how much value they are likely to add. For example, while a new roof may increase your home’s appeal, it is also a significant expense. More affordable updates, like interior painting, can refresh your space without breaking the bank.

Paraphrasing text from "Yahoo Finance" all rights reserved by the original author.