Building Home Equity
Equity is the percentage amount of your home that you actually own. It’s like building a savings account – the more you put toward it, the more you have. Here are the four basic ways you have to build your ownership stake:
1. Down payment. You gain instant equity when you put a down payment. If you put 20 percent down of the purchase price, your equity ownership is 20 percent and your lenders is 80 percent.
2. Purchase price. You can also gain instant equity by buying your home below the market. That’s difficult to do because homes don’t typically sell below market unless there is some sort of problem, such as poor condition, lack of updates, or a stigma such as a foreclosure. To build equity, invest in updates and repairs that bring your home up to the neighborhood’s standards.
3. Paying down principal. As you pay your mortgage, little goes toward reducing the principal at first while a lot goes toward paying interest. The longer the term of your loan, the less quickly you’ll build equity because the lender wants to be paid interest first. If you can, pay a little extra on your mortgage. Having a paid-for home one day is a wonderful thing.
4. Time. Historically, home values tend to beat inflation by one or two percentage points annually. You can estimate a rise in your home’s value to average about three to five percent annually in a normal market.
Another way to understand equity and how it’s built is how lenders view it. According to BankofAmerica.com, you can calculate your equity based on current appraised value less any mortgages tied to your home. If your home is appraised at $400,000 and you owe $120,000, then your equity is $260,000. But that doesn’t mean you have savings of $260K; it just means that you have a general idea of how much your home will yield should you sell it at that moment - less closing costs, of course.
Having equity can impact you financially in other ways. To refinance your loan or to determine whether you can eliminate paying private mortgage insurance, take the appraised amount of your home and divide it by your loan balance to get a percentage of how much equity you have. Divide your current loan balance by your home’s appraised value, then multiply by 100. ($120K ÷ $400K = 35%) That means you own 65% of your home. If you own more than 20 percent of your home, then most lenders will eliminate your mortgage insurance payments, which will help you add even more equity, unless you have a mortgage that doesn’t allow it. In that case, you can refinance and hopefully get a better interest rate.
Keep in mind that these numbers are theoretical until you sell your home. Meanwhile, watch your savings grow on your monthly mortgage statement!