What Is Home Equity? Why It Matters and How To Build It

You’ve likely heard that building home equity is one of the major advantages of owning a home. But you may have questions about how it works, or if building home equity makes first-time homebuying worth it. 

Below, we review what home equity is and why it’s important, and we break down some of the achievable steps you can take to grow yours. 

What Is Home Equity? 

Home equity refers to the value of your home that you own free and clear.

Building your home equity refers to increasing the value or percentage of your home that you own, usually through paying off your mortgage. 

How to Calculate Home Equity

You can calculate your home equity by subtracting your mortgage balance from your home’s current market value. 

Home Equity = Appraised Value – Mortgage balance

Home Equity Percentage = (Home Equity/Appraised Value) x 100 

For example, if the appraised value of your home is $450,000, and your mortgage balance is $100,000, your home equity is $350,000. In this instance, your home equity percentage is 78%, meaning you own 78% of your home outright. 

The Benefits of Home Equity

Building home equity is one of the most reliable ways to build wealth and grow your net worth — all from the place you live. 

Benefits of building home equity include: 

Borrowing Against Your Home’s Value

Most lenders typically allow you to borrow up to 80% of your home’s value. So, once you have a home equity percentage greater than 20% you can start borrowing money against the value of your home with a home equity loan or a home equity line of credit. 

With this, you can pay off existing debts and increase your creditworthiness — bringing positive ripple effects such as lower auto insurance rates and cheaper loans. The higher your home equity, the more money you’ll be able to take out against your home. 

Let AAA help you with a home equity loan.

Making a Profit When you Sell 

Even in a market that’s less favorable for the seller, with higher home equity, you’re more likely to be able to sell your home for a profit. You can reinvest this in your new property, increase your disposable income, or take steps toward achieving your long-term financial goals. 

Building Long-Term Wealth

Though renting offers flexibility, it does not offer the same opportunities for reinvestment as homeownership. Unlike a car, property is one of the few significant purchases that typically does not depreciate.

Generally, your house will appreciate, helping you to build long-term wealth and increase your net worth. This is especially true if the market was in the buyer’s favor when you bought, and your property value has increased significantly over time. 

With a higher network, you’ll enjoy more financial flexibility and greater accumulated wealth to leave behind to your loved ones. 

How to Build Wealth With Home Equity

Unfortunately, you can’t control the housing market — but there are plenty of steps you can take to help increase your home equity and accumulate wealth.

Make a Large Down Payment

The higher your down payment, the more of your home you’ll own outright and the greater your home equity. Remember, the percentage of your home financed by the bank does not contribute to home equity. 

Avoid Mortgage Insurance

Mortgage insurance is an additional charge to your mortgage payments. Without these payments, you’ll be able to pay off your principal and build your home equity faster. 

Shop for Low Interest Rates

Some mortgages offer lower interest rates than others. Shopping around can help you find the lowest rates.

Mortgages with terms shorter than the standard 30 years typically come with lower interest rates, helping you build equity more efficiently. Note that these types of loans typically come with higher monthly payments. 

Increase Property Value

Renovations increase your property’s value, thereby increasing equity. Renovations with the highest return on investment include:

• Kitchen and bathroom remodels.
• Energy-efficient upgrades.
• Usable living space, like a basement conversion or deck.

Minor home improvement projects — like sprucing up your landscaping or repainting bedrooms (known as sweat equity) — might not raise your home’s value outright, but can enhance its appeal and attract more buyers.

“There are very few home improvements that increase a home’s value dollar for dollar,” said Steven Vieira, director of mortgage operations and sales for AAA Northeast. “However, there are a lot of small projects a homeowner can do, like painting garage doors and power washing the exterior, that can make your home more desirable in a competitive market. It’s recommended, particularly in situations where the condition of the home may be below the standards of the neighborhood.”

Learn more about using a home equity loan for renovations. 

Pay More on Your Mortgage

Initially, most mortgage payments go toward paying off the interest rates. After a time, payments go toward the principal and increase your home equity. 

Contact your mortgage provider if you’re able to afford higher monthly payments or are in a position to make a large one-off payment toward your mortgage. The faster you pay off your mortgage, the faster you’ll grow your home equity. 

The Long-Term Benefits of Home Ownership

Though the housing market fluctuates, property is one of the few investments you can make that helps you build your wealth over time. 

Home ownership can feel like a big step, but investing in home equity helps you work toward your long-term financial goals, including: 

• Greater borrowing flexibility.
• Increased financial freedom.
• Ability to pay off debts and increase your credit score.
• Secure lower interest rates on new loans.

“Home ownership is the primary driver of wealth for the middle class. A homeowner’s net worth is typically 43 times that of a renter over time, according to the National Association of Realtors. It’s also the primary driver of generational wealth,” said Vieira.

Ready to learn about mortgage options and start building your home equity? Get mortgage help from AAA Northeast.