Building equity is one of the main benefits of owning a home. You don’t see it happening while it’s happening, but the aftermath is quite rewarding.
If all goes well, you end up with a significant asset that you can use for almost anything.
What Exactly is Equity?
Equity is an amount of your home you truly “own”. You are considered to own your home if you bought it but if you borrowed money to finance this purchase, your lender, usually a bank, has an interest in it until you pay off the loan. To calculate the value of your home equity, subtract your loan balance from the market value of your home.
If the result of your calculation is a negative number, meaning that the home is worth less than you owe for it, you have negative equity.
For example, your home is worth $300 000, and you still have $200 000 outstanding balance on your loan. Your home equity is then $300 000 – $200 000 = $100 000.
What can you do with your Equity?
- You can receive cash if you sell your home and pay off any remaining costs
- You can use if for a down payment for your second home purchase
- Borrow against it with a home equity line of credit (HELOC)
The more equity you have, the better. There are two ways you can build home equity:
- Repay your loan
- Increase your property’s value
You can take either active or passive approach to building your home’s equity. If you choose the passive approach, you just keep paying off your mortgage installments every month and your debt will decrease, thus your equity will increase. But if you decide to be more active about raising your home’s equity, below are some tips on what you can do.
Decrease your debt
- Keep making your monthly payments. If you are like most people, you probably took a mortgage to finance your home purchase. Even if this was already mentioned above in a passive approach of building equity, making your monthly payments on your mortgage is key.
- Choose shorter-term loans. Shorter-term loans usually have lower interest. This means that a larger portion of your monthly payments will go to your principal and less to the interest you pay to your bank. A lower interest combined with the fact that you’re paying interest for a shorter period of time means you build equity faster.
- Consider extra payments. Even if you have a 25-year mortgage, you can speed things up by paying extra. Every extra payment will add money to your equity, just make sure your bank applies this amount to your principal. If you can afford to pay extra, nothing prevents you from setting up a 15-year repayment plan even if you applied for a 25-year mortgage. If, at some point in time, you can no longer afford to pay extra, you can always go back to your smaller 25-year plan payments, but you have already built more equity when you did those extra payments.
- Refinance your loan. Do your research and see if refinancing is a good idea in your case and at the moment when you wish to refinance. It could be a good move as refinancing usually mean lower interest and potentially shorter-term loans, which is always a good thing. Note that refinancing is not always helpful, so we advise to get informed first.
Increase your property’s value
Your home’s market value is a key factor in how much equity you have at a given moment in time. The higher the value, the more equity you have. What are the things that can increase a home’s market value?
- Rising prices in the market where your home is in. If you are lucky, your home’s value will increase over time without any action on your part. This is more likely to happen in attractive neighborhoods or growing towns.
- Home improvements. You can raise your home’s value by investing in home improvements. Updating kitchens and bathrooms, changing floor plans to increase square footage, improving landscaping and making the home more energy-efficient will pay off. However, this means you need to invest some money upfront. To get the most out of your investment, chose the projects with the highest ROI. As an additional benefit, while you are using the home you will be living in a newer and a more modern house compared to how you bought it.
- Maintain your property well. Routine maintenance might be tedious and sometimes expensive, but a well-maintained house will attract more potential buyers who are be willing to pay for a quality home. If you fail to address some major maintenance issues like leaks, deteriorating roofing and such, your property’s value will decrease over time.
These are the main things you can do to increase your home’s equity. With a home, your main asset isn’t cash in your savings account, it’s equity in your property. Make sure you maintain it well, do some home improvements and your home equity might rise higher than you expected.