How do you build equity in a home? That’s a question that many homeowners ask themselves as they begin to think about the value of their home, especially if they’re planning on moving or selling it in the near future. A good way to build up equity, or the value of your home, is to make smart financial decisions and maintain responsible ownership over time. By following these steps and maintaining good habits, you can build up your equity in no time!
What does it mean to build equity in a home?
First, let’s discuss what home equity really means. Home equity is the difference between what you owe on any outstanding liens against the property and what your home is currently worth. A lien is a legal right or claim placed on a property by a creditor. For a home, a lien could be a first mortgage when you buy the home, or a second mortgage such as a home equity loan or home equity line of credit (HELOC). As an example, if you have a first mortgage principal balance of $175,000, a home equity loan balance of $15,000, and a fair market value of your home assessed at $323,000, your home equity would be $133,000. Using this example, it’s easy to see that a decrease in the amount of what you owe, or an increase in the value of your home are ways to increase equity in your home.
Make a bigger down payment to create immediate equity
If you want to build equity as soon as possible, it may be worth considering putting 20% down or more when you purchase your home. This option might not be available to some people—depending on how much cash they have available for a down payment—but it’s definitely something to consider if other factors allow. You’ll also need to take into account that closing costs will eat into whatever money you have available to put down up front if you as the buyer have to pay them. Even if the seller agrees to pay closing costs, that tactic is often offset by an increase in the purchase price which negates the up-front equity impact of your down payment. See below for an example of how much equity you would have in your home based on the lower remaining principal payment after 5 years by increasing your down payment from 10% to 20%. Subtract the amounts in the balance column from $330,000 to calculate the equity.
Purchase price of the home: $330,000 and a mortgage start date of 2/12/2022
How choosing the right location can impact equity
Location is one of many aspects that can impact your home’s resale value. It doesn’t matter how great your house is if no one wants to live there—or if you’re forced to sell at a loss. Below are some factors related to location that can have an effect on property values.
- Demographics of existing homeowners or potential buyers – Property values depend on supply and demand. Typically, if demand is greater than supply, property values will rise based on buyers competing for the same homes and placing higher offers so they don’t lose out. As an example, if your home is in a location that is attractive to younger buyers looking to purchase their first home, or older buyers looking to retire, your property value can rise as a result of demand for homes in an area certain buyers are searching for.
- Surrounding amenities – proximity to schools, businesses, hospitals, recreation, transportation, and shopping can all have a positive impact on market value and buyer demand.
- Distance to surrounding amenities – if desirable amenities such as transportation (very close highways or railroad tracks), the type of businesses nearby, and shopping (traffic) are too close, they can have a negative impact on equity because potential buyers may shy away or make lower offers.
- Be first – If you do your homework and buy or build a home in an area that has not attracted a lot of attention yet, but looks like it will in the future, you may be able to capitalize on a property value explosion as a new local home market surges in your area.
Location is important when looking for a house to buy for yourself or an investment. Read this article for more information on why location is important. Some of the factors within the article may also impact your ability to build equity.
Watch out for interest rates
If you are looking to get a loan, interest rates on mortgages and home equity lines of credit can fluctuate from one day to the next. Don’t assume the advertised mortgage or HELOC rates will stay fixed at a certain percent indefinitely. Check out the graph below to see how a 1% difference in interest rates can impact building equity in your home. Between years 11 and 22 during the loan term in this example, the difference in equity can be over $10,000!
Refinancing to a shorter loan term can also help you build equity faster, especially if the interest rate on the new loan is lower. If you have an adjustable-rate loan, it may pay off to keep refinancing even though it requires time and effort—at least until interest rates start rising again if they have been low or declining in recent years.
Build equity in a home by making extra principal payments
When you make a mortgage payment, your payment is split between the interest your lender applied to the amount you borrowed, and the amount the lender loaned you minus your down payment (beginning principal balance). As you may have noticed in the graph above, overtime, your principal goes down faster in later years of your mortgage term. This is due to the fact that you pay mostly interest at the beginning of your loan and mostly principal at the end of your loan. This gives the bank a better chance to reap profits early, but delays your ability to build equity. Here’s two ways to beat the bank at their own game. First, make bi-weekly payments. To use this method, you would send half of your mortgage payment every two weeks instead of one monthly payment. This allows you to make one extra mortgage payment each year which will allow you to build equity faster, pay less interest, and pay off your loan sooner. Second, anytime you have extra income available, consider using all or a portion of the surplus to make a payment to your lender that is applied solely to the principal balance of the loan. If you can, do this every month.
Don’t overextend yourself financially
It’s important not to overextend yourself financially when building equity. The last thing you want is for your home loan payments and other bills to eat up all of your monthly income, leaving you struggling every month just to make ends meet. Instead, try to keep debt at or below 30% of your total income. This will help ensure that you always have enough money coming in each month so that you can build some extra equity with extra principal payments while still having enough left over for daily expenses.
View your home as an investment to build equity
To build equity, you have to look at your home as an investment. True, your home is really a liability when listed on a balance sheet because it is something you owe due to your mortgage or other loans. Investments are in the asset section of the balance sheet because they are something you own that provides a potential economic benefit such as stocks and bonds. Viewing your home as an investment means that you look at the future potential economic benefit of paying it off which turns it into an asset (something you own free and clear), or the potential to leverage the equity in your home as it grows. If you approach home ownership in this manner, you will proactively think about paying off your mortgage early or making decisions that will positively impact your ability to build equity. You will also factor equity into your planning when you are ready to purchase your next home.
Keep the home clean, safe, and well maintained
Your home can become your greatest asset, but only if you treat it like one. By keeping it clean, safe, and well maintained, you can ensure that your investment is protected. Here are some tips for doing just that: 1) Keep your home as weather-proof as possible. Water damage, poor insulation, cracks in walls or foundations—all of these factors will reduce your home’s overall value. 2) Make sure repairs happen promptly. If something breaks or stops working in your house, get it fixed right away so you don’t end up with long-term damage or increased maintenance costs down the road. 3) Pay attention to updates and remodels. A new kitchen, bathroom, flooring system—these things matter when it comes time to sell your home. Keep reading below for more about home improvements. Whether you are living in your home or someone else, here is a great article outlining common items to stay on top of and associated costs when maintaining a home.
Staying put is the easy way to build equity in a home
One of the best ways to build equity is just to stay put and watch it grow. Make your payments on time and continue to stay on top of the maintenance as mentioned in the previous section. Of course, if you’re seriously thinking about selling, there are also some things you can do before placing your home on the market that will help build up your equity. You might want to get a home appraisal or make home improvements such as adding a deck or finishing a basement; these investments will increase your home’s value or ensure that you can get the full amount of the market value of a home like yours that is in good condition. Taking action to increase equity before you sell can also position you to put down that bigger down payment on the next property after you sell your existing home.
Make home improvements to build equity in a home
When it comes to building equity, making home improvements is an excellent strategy. When homeowners improve their property—such as adding new paint or gutting and renovating an old kitchen—they boost its value. For example, if you put $10,000 into renovating your kitchen and re-doing your bathroom, your house may be worth around $20,000 more than it was before you made those improvements. So that’s free money for doing something that will pay off in the long-term and something you can enjoy right now!
In conclusion
Despite what you may think, building equity is not about putting your head down and investing for decades. Rather, it’s about buying at good value, paying your mortgage off early or reducing your principal faster (when possible), and watching your home’s market value appreciate steadily over time. Armed with these three simple steps, you can enjoy real estate success over many years—and build equity faster than you ever thought possible!
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