Understanding Home Equity: How It Works and Best Practices for Building and Utilizing The Equity In Your Home

Every month, as you diligently make your mortgage payment, you might find yourself wondering when you will truly get to enjoy the major financial perks of homeownership - having funds.

And, that’s where your home’s equity comes into play!

Home equity serves as a valuable asset that homeowners can leverage to finance various things in life (and in some cases even build wealth)!

In this comprehensive guide, we’ll delve into the definition of home equity, options for accessing it, and discuss how to build home equity.

Last but not least, we’ll also share the best way to access and use home equity.

Alright, now let’s get down to the nitty-gritty!

What is Home Equity and How Does It Work?

So, what is equity in a home?

In simple terms, home equity is the portion of your home’s value that you truly own. It is the difference between the current market value of your property and the remaining balance on your mortgage. Home equity represents a financial asset that can be tapped into for various purposes, including building wealth and financing major expenses like home improvement projects. 

As you make mortgage payments over time, your equity increases and you have the option to leverage that equity if you so choose.

Home equity works like a savings account that grows over time as you pay down your mortgage and your property appreciates in value.

The more you pay off your mortgage and the more your home’s value increases, the more equity you build. Home equity can be tapped into for various purposes, such as home improvements, debt consolidation, or other financial needs. Home equity provides you with a valuable asset that you can use to your advantage!

To get an even better understanding of how home equity works here’s an example

Let’s say you bought a home for $250,000, and you made a down payment of $50,000 (20% of the purchase price). This means you needed to take out a mortgage of $200,000 to cover the rest of the cost.

After a few years of making mortgage payments, the remaining balance on your mortgage is now $180,000. During this time, the value of your home has also increased due to factors like the real estate market and any improvements you’ve made. Let’s say your home is now appraised at $300,000.

To calculate your home equity, subtract the remaining mortgage balance from the current appraised value:

Home Value: $300,000 Remaining Mortgage Balance: $180,000

Home Equity: $300,000 - $180,000 = $120,000

You have $120,000 in home equity!

Technically, you own $120,000 worth of equity in your home and the mortgage lender owns the rest. You can potentially use up 80% of this equity for various purposes, such as taking out a home equity loan, getting a home equity line of credit (HELOC), or using it as collateral for things like home improvements.

Home Equity Expert Tip: RenoFi offers a unique approach to accessing your home equity via home renovation financing. With RenoFi, you can potentially tap into more of your home’s equity by adding the future value of a planned home renovation to the equation.

This allows you to leverage more of your equity, potentially getting you more funds to complete rennovation projects or major home improvements. By using this strategy, RenoFi helps homeowners unlock additional funds to invest in their homes, all while leveraging their existing home equity in a smarter way.

Click the button below to see how RenoFi can help you leverage more of your home’s equity via a home renovation loan.

How Does Home Equity Work When Your House is Paid Off?

When your house is fully paid off, you gain complete ownership of your home’s value. With full ownership, your home equity equals the current market value of your house. Since you no longer owe any mortgage or loans against it, your home equity is maximized.

At this stage, you can access your entire home equity through options like home equity loans or HELOCs. This is different from when you had an outstanding mortgage balance, and the bank referred to a portion of your equity as “usable equity.” With complete ownership, you have the flexibility to tap into the entirety of your home’s equity for various financial needs.

How to Calculate Home Equity

To calculate your home equity, subtract the outstanding mortgage balance from the current market value of your home. Below are general steps to calculate home equity.

Step 1:

Determine Your Home’s Current Market Value: Use online real estate platforms, recent property sales in your area, or consult with a real estate agent to estimate your home’s current market value.

Step 2:

Calculate Your Outstanding Mortgage Balance: Check your most recent mortgage statement to find the remaining balance on your mortgage.

Step 3:

Subtract Mortgage Balance from Market Value: Subtract the outstanding mortgage balance from the estimated market value. The result is the estimated equity in your home.

Remember……

Home equity is a dynamic factor that can change over time due to various influences. Several factors influence the value of your home equity, including market conditions, property improvements, and the overall real estate landscape.

Factors Affect Your Home Equity Value

• Mortgage Payments: Regular mortgage payments gradually reduce your loan balance, and build your equity over time.
• Home Improvements: Renovations and improvements can raise your home’s value, leading to an increase in equity.
• Local Real Estate Market: Economic conditions and demand in your area influence property values, affecting your home’s equity. As your home appreciates in value due to market conditions, your equity naturally increases. The market value of your home significantly impacts your equity. Appreciation in property value can increase your equity, while depreciation can decrease it.
• Market Conditions: A strong seller’s market with high demand can drive property values up and boost equity. High demand for housing in your area can lead to property value increases, thereby building your equity.
• Maintenance and Upkeep: Properly maintaining your home can help preserve or enhance its value, which impacts equity.
• Renovation Projects: Home improvement projects can increase your home’s value and, consequently, your equity.

10 Ways To Build Home Equity

Looking to tap into your home equity and access funds through a home equity loan or line of credit?

You might be curious about how you can accelerate the growth of your equity and maximize borrowing potential.

Home equity loans and lines of credit are attractive options due to their lower interest rates compared to personal loans. Whether it’s covering education costs, medical expenses, or home renovations, homeowners frequently opt for home equity financing.

However, keep in mind that you’re typically limited to about 90% of your current home value, minus any outstanding mortgage balance (but you can get much more with a RenoFi Renovation Loan).

Here are effective strategies to boost your home equity:

Accelerate Mortgage Payments: Speed up equity accumulation by paying more than the minimum on your mortgage. Consider making extra payments towards the principal each month, and confirm that the payment goes towards the principal, not interest. Biweekly payments and directing unexpected windfalls toward your mortgage can also expedite equity growth.

Enhance Property Value: Increasing your home’s value through improvements is another avenue to build equity. While you may not recoup all costs, certain projects offer notable returns. Consult professionals for high-return home projects, opt for cash-friendly projects like painting and light fixture updates, and enhance curb appeal with landscaping and small exterior upgrades.

Substantial Down Payment: When purchasing a home, a larger down payment instantly boosts your equity. While minimum down payments can be as low as 3.5%, aiming for a 20% down payment significantly accelerates your equity-building journey. However, ensure a balance between down payment size and maintaining a financial safety net.

Patiently Await Appreciation: If time is on your side, wait for your home’s value to appreciate. Regular on-time payments naturally increase equity over time, unless unforeseen events impact housing values. Be aware that housing market fluctuations influence equity levels. To monitor value, use online tools or consult appraisers.

What Can You Do With Home Equity?

Complete Home Renovations Projects: Using home equity to fund renovations or upgrades can increase the value of your property and improve your living space. This investment may provide long-term financial benefits.

Consolidate Debt: You can use home equity to consolidate high-interest debts like credit card balances or personal loans. This could potentially reduce your overall interest payments and simplify your finances.

Finance Your Education: Home equity might be tapped into to cover educational costs, such as tuition fees, for yourself or your family members. However, consider the long-term financial implications before using equity for this purpose.

Pay for Major Emergency Home Improvement Expenses: In times of unexpected financial needs, using home equity might provide a lower-interest borrowing option compared to other sources like credit cards or personal loans.

Is it a Good Idea to Take Equity Out of Your House?

Ways to Take Equity Out of Your Home

It’s important to understand the pathways that will empower you to leverage your property’s equity effectively. Explore the ways you can access your home equity below:

Use a Home Equity Loans

Home equity loans are a  type of loan that provides a lump sum of money with a fixed interest rate and set repayment terms.

It is an ideal option for large expenses, such as major home renovations or debt consolidation. Borrowers are responsible for repaying the home equity loan according to the agreed-upon terms. This typically involves making regular monthly payments over a fixed period, often ranging from 5 to 30 years.

Home equity loans come with a downside - your home is used as collateral to secure the loan.

Home Equity Expert Tip: You can minimize the risk of a Home Equity Loan by ensuring you can afford payments. As such, you should opt to get the lowest interest rate possible. RenoFi Home Equity Loans have low fixed rates for those in need of home improvements.

Consider a Home Equity Line of Credit (HELOC)

HELOCs function similarly to credit cards, offering homeowners a line of credit that they can access as needed. Borrowers can withdraw funds up to a predetermined limit during the draw period, which is typically 5 to 10 years. The interest rate on a HELOC is usually variable.

During the draw period, homeowners can make interest-only payments or pay both principal and interest. After the draw period ends, a repayment period begins, during which borrowers must repay both the principal and interest.

HELOCs provide flexibility, but they also carry the risk of unpredictable payments - due to the fact that HELOCs usually come with variable interest rates which can increase potentially resulting in higher payments. It’s essential to have a clear plan for utilizing the funds and to carefully consider the potential fluctuations in interest rates.

Another major downside of HELOCs is that the lender determines the funding based on the current value of the home, not its post-renovation value - however, a RenoFi HELOC loan solves this problem.

With a RenoFi Loan, you can borrow against the anticipated value of your home after completing renovations. We evaluate your home’s current value and assess the after-renovation value based on the renovation plans you submit.

This approach allows you to access funds that match the potential increased value of your home, providing a flexible and customized financing solution for your renovation project.

Home Equity Expert Tip: When it comes to accessing your home equity for home renovation financing, it’s important to recognize the significant differences between a Home Equity Loan (HELO) and a Home Equity Line of Credit (HELOC). Be sure to select the option that best aligns with both your project’s requirements and your financial circumstances.

Get Cash with Cash-Out Refinancing Options 

Cash-out refinancing involves replacing your existing mortgage with a new one that has a higher principal amount. They receive the difference between the new mortgage and the old one in cash, which you can use for various purposes, including home renovations. After completing the refinancing process, borrowers must repay the new mortgage according to the agreed-upon terms, which may include monthly payments over an extended period.

Cash-out refinancing can be a viable option for leveraging your equity, but it’s important to consider the closing costs associated with refinancing.

Home Equity Expert Tip: Unlike refinancing, which involves replacing your existing mortgage with a new one, using a HELOC you can take equity out of my house without refinancing. This can be especially advantageous if you’ve locked in a favorable interest rate on your primary mortgage.

Use a RenoFi Loan

RenoFi Loans are a new type of home equity loan option that allows you to use your home equity to finance renovations - but your borrowing power is based on your home’s after-renovation value, rather than the current value. This factor allows homeowners to borrow 11x more on average than traditional home equity loans.

How Much Can You Borrow From The Equity You’ve Built in Your House? 

Lenders typically allow you to borrow up to 85%  of your home’s appraised value (pre-renovation) minus any outstanding mortgage debt.

But wait, there’s more good news!

If you’re planning to do home improvements, you can boost your future home value, thus enabling you to borrow against more of your home’s equity.

When it comes to home renovation loans, the amount of equity you can borrow also depends on your after-renovation value.

For many individuals seeking to utilize funds for home renovations, traditional lender loans often fall short in providing sufficient funds to cover the average cost of a kitchen remodel or bathroom renovation which are among the most common home improvement endeavors.

Home Equity Expert Tip: RenoFi loans stand out as the sole genuine renovation loans that enable you to leverage home equity while also considering the after-renovation value. Due to this unique approach with a RenoFi Loan, you can borrow anywhere from 90% to 150% of your current home’s value, ensuring you have the necessary funds to complete your renovation. “Homeowners who will find RenoFi’s new home loans helpful are those who recently bought a home and have not yet built a meaningful amount of equity to tap,” RenoFi founder Justin Goldman told HousingWire.

Click the button below to see how RenoFi can help you leverage more of your home’s equity via a home renovation loan.

How RenoFi Helps You Build Home Equity

For new homeowners that want to renovate their homes, home equity loans are often out of reach for years - which is why we’ve created RenoFi Loans. 

Just looking at the example below, these homeowners won’t be able to take advantage of their home equity to fund a major remodel for an entire decade. 

Right now, most homes on the market are older - which means even if homeowners aren’t looking to make aesthetic changes, their homes will still need updates. 

RenoFi Loans allow “equity-light” homeowners to not only utilize their home equity sooner and borrow more, but also make changes through renovating that will increase their home’s value. 

Sound pretty great? Click the button on the right to Find A Lender.