It does that by letting you build home equity, which is the difference between your home's market value and what you owe on it. Your equity increases with each house payment you make. When home prices rise, your equity grows faster as your home's value increases.
Stockpiling home equity gives many savers an exceptional feeling of satisfaction. Those forced savings also are a mighty resource to tap if you're hit with an unexpected expense or want a boost on one of life's milestones, like helping a kid through college or upgrading the home.
For these big life expenses, you can draw on your equity with a home equity loan or line of credit. The secret is moderation. Remember, building equity is often worthwhile, but you need to keep your financial life in balance by responsibly paying off debt, saving for retirement and being ready for emergencies.
To step on the gas and speed up the growth of equity, you've got two main tools: You can increase the home's value or reduce the mortgage debt. Or both.
Here are six tips to help you build home equity:
Get equity from the start with a larger down payment, since that is instant equity. Put down 20% or more of the property's value for a bonus: You'll avoid pricey private mortgage insurance.
Talk about forced savings. Taking out a 15-year mortgage, or refinancing into one from a 30-year loan, piles on the equity -- and at a lower interest rate. You'll save plenty on the total interest, too, because you pay interest for less time. But remember, there's a catch: Your monthly payments are higher with a 15-year home loan.
"Homeowners should concentrate on reducing their mortgage in order to gain equity," says Roslyn Lash, a real-estate broker whose company, Youth$mart Financial Education Services, aims to educate teens and millennials. Refinancing into a 15-year loan can be "a great way to build equity because a lower rate means that more money is applied to the principal," says Lash, who also is an accredited financial counselor.
Some remodeling and improvement projects boost a home's equity. But not all do. The average payback on common upgrades is 64 cents for each dollar spent, according to Remodeling magazine's research. And that's if the home sells within a year. Smaller projects -- adding attic insulation, replacing a garage door or front entry door -- do better at increasing equity, especially if you pay with cash instead of via a loan.
Paying more can be a good option. If you decide to do this, make sure the extra money is applied to your mortgage principal. Ask your mortgage servicer (you can find the phone number on your monthly statement) how to do it and watch your monthly statements to be sure the money is credited correctly. Here are a few ways to pay more regularly:
o Add an extra sum to your monthly payment. Pick an amount big enough to make a difference but not so big that it crimps your budget. For example, if your payment is $983, round up to $1,100, and then increase the amount when you're able.
o Another version of adding to your monthly payment: Boost the payment by an amount equal to a twelfth of a payment. By the year's end, you'll have made an extra payment.
o Switch to biweekly mortgage payments. Paying every two weeks instead of monthly adds one extra monthly payment to your mortgage annually.
o Schedule extra payments automatically from your bank to your mortgage account at regular intervals
If you don't want the commitment that comes with a 15-year mortgage or increasing the size of your payment, look for cash that dribbles in here and there. Holiday and birthday gift cards? Convert them to cash and add it to your mortgage. Dedicate overtime pay, bonuses or every other bonus to building equity. Cash gifts? Ditto.
If you are fortunate enough to inherit money, use at least part of it to pay down the mortgage. Your mortgage servicer can tell you how to add dribs and drabs or a big windfall to your equity. As before, make certain the money goes toward the principal, not interest.
Couples who want to bump up equity in a hurry sometimes take the route of living on one salary while committing the other person's paychecks to paying down the mortgage.The belt-tightening can be demanding but the rewards can be extreme.