To build equity in your home, you can use these easy steps.
“Equity” is simply the percentage of the property you own compared to the percentage you still owe on the mortgage. It takes into account a few different factors, but most importantly it is a way of describing how much you own and how far you are from paying off the property completely.
If you purchase a home outright and completely, with no loan whatsoever, you have 100% equity. However, if the home is worth, say, $500,000 and you borrower $500,000 for the purchase, you have 0% equity. If, on the same home, you only needed to borrow $250,000, you have 50% equity. It’s also possible to have “negative equity” which means you owe more than the home is worth.
High home equity creates a mixture of benefits. It gives you access to lines of credit, gives you more options when you decide to “move up” in housing, and can act like a forced savings account.
Ways to Build Equity in Your Home (Beyond Regular Payments)
The most common way to build equity is to simply make your payments. But there are other options that help accelerate the process.
Have a Large Downpayment
Downpayments are automatic equity in your home. For example, if you place a 20% downpayment on the purchase of a home, you are (essentially) starting homeownership with 20% equity. This gives you a tremendous boost to your overall ownership of the property from the very beginning and could also make your monthly payments more affordable, as certain elements like mortgage insurance could be eliminated. A high downpayment could also reduce your interest rate, freeing up future cash that could be rolled into the balance of the mortgage.
Saving for a downpayment is, of course, extremely difficult, but any savings you can bring will create automatic equity. To start with some positive equity, research potential downpayment-assistance programs that could be available in your area. There are numerous community development programs and and non-profit organizations that may be able to help.
Make Larger Monthly Payments
Mortgage payments cover both the interest and the principle. Most mortgages function on an amortization schedule, which basically determines how much of the payment goes to the interest and how much goes towards the principle. To start, a larger portion will go to interest, while the portion that goes to the balance will grow over time. If you can afford it, make extra payments towards the balance on your mortgage, which will increase overall equity. (The lower your balance, the higher your equity.)
There are countless ways to make larger payments. Some couples dedicate the entirety of one person’s income to the mortgage. Some add 10% to the mortgage payments. You could also schedule an extra payment at any given interval, or setup payments to be every three weeks instead of a month. The difference may seem small at first, but over the course of a 15- or 30-year mortgage, it will have a strong impact.
Put Extra Cash Directly into the Mortgage
If you are dedicated and disciplined towards increasing equity as fast as possible, one of the best techniques is to place any additional income into your mortgage. If you come across a large or small sum of money, such as gifts or work bonuses, resist the temptation to purchase a new item (that will likely be buried in all your other stuff) and churn that cash right into your mortgage.
Potential sources of extra cash can include…
- Work bonuses
- Holiday gifts
- Money from sold items
- Tax returns
If you don’t need the extra cash other purchases, it may be wise to simply use it to build equity.
Let Your Home Gain in Value
Of all the possible ways to build equity in your home, this is by far the most passive. (Or at least, it can be the most passive.) Over the years, your home will most likely gain in value. Property, especially real estate property in decent town, cities, and areas across the country, has a long track record of growing in value. As the saying goes, they are not making new land anymore, so demand for property and housing will always be there.
As your property increases in value, you automatically gain equity.
We’ll use a simplified and exaggerated example to make this point: Suppose you purchase a house valued $500,000. You had a $50,000 downpayment (10%) and borrowed $450,000. This means from the start you had 10% equity in the property. Now let’s imagine that ten years go by and the property went up in value to $600,000. To keep it simple, let’s just assume that you magically made no payments (and were somehow not foreclosed on!) and still owe exactly $450,000 to the bank. Now you owe $450,000 on a home worth $600,000, which means you own $150,000 of the property. By simply doing nothing and letting the home increase in value, your equity increased from 10% to 25%.
This is, of course, a fantasy example. For one, your home probably won’t increase that much, although the gain over ten years is not outlandish. For another, you would make regular payments, which would reduce your overall balance. But it demonstrates the power of time and appreciation in property value.
Are Renovations Worth It?
By simply letting time pass, you will likely see an increase in the home’s value, but you can also make improvements to the property to increase its market price. Renovations, however, rarely bring a full return on the investment. According to Remodeling Magazine, most renovations bring less in home value than they actually cost.
For example, a manufactured stone veneer has a national average cost of $9,357 yet only adds $8,943 in home value. Yes, you’re adding to the value of the home (and thereby building equity), but you’re doing so at a higher cost.
If building equity is the main goal of the renovations, and we are simply looking at it from a financial perspective (and not a home-enjoyment perspective) then it would be better to skip the renovations and simply roll the money into the mortgage.
Get a Loan that Fits Your Specific Goals
Whether your goals are to build equity fast or maintain a low monthly payment, we can help you find the right loan for your specific needs. Contact our team and find out why we are the trusted source for common-sense mortgage underwriting in San Diego, California and the surrounding area!