What Is Home Equity?

If you’re considering buying property, you’ve probably heard a lot about the importance of building home equity. If it’s been a few years since your last economics or finance course, don’t worry — we’ll provide you with a quick refresher on how home equity works and discuss the benefits of building it.

There are a few components involved in the purchase of a home: your down payment, your mortgage amount, and your equity. Let’s say you’re looking to purchase a home for $100,000 and have 20% — $20,000 — saved for a down payment. Your mortgage amount will then be $80,000, and your down payment will be converted into equity once the home sale is complete.

Every time you make a mortgage payment, the part of your payment that goes to pay down your remaining balance — also known as your principal — is put toward your equity. Viewed from this perspective, equity is the amount of money you have invested in your home, minus the remaining balance of your mortgage.

Can My Equity Increase Outside Of Making Mortgage Payments?

Yes. If the value of your home appreciates — such as if housing market values in your neighborhood increase and the value of your $100,000 home jumps to $120,000 — you earn equity.

Additionally, you can take a more active role in building your home’s equity. If you make aesthetic or functional improvements to your home — such as installing new energy-efficient windows or renovating your garage — you can help increase its value, which can grow your equity. Not all repairs or improvements will have this effect, however, so you should conduct a cost-benefit analysis before embarking on a home improvement project if isn’t absolutely necessary.

What Can Home Equity Be Used For?

Home equity is useful for a number of purposes. At its most basic, it can help you net more money when you sell your house. It can be used to secure a second loan, as lenders will allow you to use it as collateral. A popular type of home equity loan is a reverse mortgage, which is offered to senior citizens who wish to borrow against a portion of their home’s equity.

Why Should You Build Home Equity?

There are many reasons why you should build home equity. It can help you amass money down the line when you are ready to purchase a new home, or it can be used to secure loans in the future if money is tight and you need an infusion of cash. Home equity is one component of a financial portfolio you can build to grow wealth for you and your family.