What You Should Know About Building Equity
If you’re in the market for a new house in the Highland Ranch area, you likely view it as not only a place to live but an investment. If you’re financially and mentally prepared, putting your money into a house can be a solid investment.
One reason that buying a home is good from an investment standpoint is that you can build equity.
The following are four important things to know about building equity in general as a homeowner.
1. What Building Equity Means
Whenever someone describes buying a house as an investment, equity is probably what they’re talking about. Equity is the dollar amount of your home that you actually own. You can calculate it as the difference between the home’s value and what you owe on your mortgage.
If you own a home with a $300,000 value and you owe $200,000, you have $100,000 in equity.
As you build equity, you’re increasing the difference between the value and what you owe on your mortgage. You can do this in two ways—you can increase the value of your home, or you can reduce what you owe on your mortgage.
2. The Importance of Equity
When you build equity, you are then putting more money into your home. You can use that money now or at some point in the future.
If you keep your home, for now, you can eventually see it for more than what you owe, and then you keep the difference. When you sell your home, your sales proceeds first go to pay off the balance of the mortgage. Then, you use the rest to buy another home, or you keep it. The more equity you have in your house, the more you’ll make if you sell it.
Another way you can use equity is to tap into it as a loan. You can borrow against your home’s equity with a home equity loan or home equity line of credit (HELOC). These loan types are second mortgages. Your home is your collateral as you borrow from your equity.
Of course, with your home as collateral, if you don’t pay your loan back, you risk losing your home.
A home equity loan provides a lump sum of money. A HELOC is a line of credit.
A cash-out refinance something that lets homeowners take out a percentage of their home’s equity, and then it’s added to their loan balance and refinanced, so the result is a new loan. You get the difference as cash, and you can put that cash toward other things.
Your equity is also a way to increase your net worth. Net worth is a calculation of what you own, which are your assets, minus liabilities, which are what you owe. The more your assets and the lower your liabilities are, the higher your net worth. As you’re paying off a mortgage and building equity in your home, you’re growing your assets and shrinking your liabilities, so your net worth is going up.
3. How to Build Equity
There are ways that you can build equity that is going to be faster than others.
If you’re in the market for a home right now, the bigger your down payment, the more equity you’re going to have instantly. Your down payment is what you put down in cash when you buy a home. When you get a mortgage, you’re typically required to pay a minimum down payment. It can be anywhere from3-20% on average and depending on the loan.
If you can afford a larger down payment, you might want to make it because then that’s all equity, and it’s money you aren’t borrowing.
Another way to build equity is to refinance and get a loan term that’s shorter. After you pay your mortgage off, you have 100% equity as long as there aren’t any other liens. If you refinance to a shorter term, you can pay your loan off earlier, plus you’ll save in interest. The monthly payments do go up, though, and you might have to pay closing costs on a new loan.
When you have a mortgage, anything you can do to pay it off faster is going to help you also build equity more quickly.
One path that people will take to pay off their mortgage faster and also reduce what they pay in interest is to make biweekly payments. You’re adding an additional mortgage payment toward your overall mortgage every year.
Rather than paying your mortgage once a month, you pay half the payment every two weeks. You end up paying an extra payment because you’re making 26 payments. There are 52 weeks in a year, and with 13 full payments, you could pay off your mortgage 6-8 years earlier.
A few other ways you can increase your equity faster are:
- Eliminating your private mortgage insurance. The only way to do this initially is to pay at least a 20% down payment. If you already have PMI on a conventional loan, you can talk to your lender about getting rid of it once you have at least 20% equity in your home. Once you have 22% equity, the PMI goes away automatically.
- Every time you get extra money or money you weren’t expecting, put it toward your mortgage so you can pay it down faster.
- Make home improvements that will increase the value.
Over time your home’s value is likely to appreciate, too, although this isn’t a guarantee. If it does, then that’s going to automatically increase your equity.
4. What If Interest Rates Are High?
There is a challenge for new homebuyers right now, which is the fact that interest rates keep going up. With inflation continuing to soar, there isn’t currently an end in sight for interest rates to stop increasing from what were record lows just last year.
While you can still buy a home and build equity even when interest rates are higher, it’s going to take longer, so this is something to take note of. Of course, your existing interest rate isn’t going to change if you have a conventional fixed-rate mortgage already.
For people who are buying, home prices are starting to dip. That’s a good thing if you’re looking for a new home, but if you’ve just bought one, it can again be a factor that increases how long it takes you to build equity.
Even with it taking longer, though, building equity is a rewarding investment, and you get the benefit of also having a home that you can use and enjoy as you pay off your investment.