What Is Home Equity?
How does Home Equity help you build wealth?
Homeownership offers many advantages over renting, including a stable living environment, predictable monthly payments, and the freedom to make modifications. Additionally, studies show that homeowners are happier and healthier than renters, and their children do better in school.
But one of the biggest perks of homeownership is the opportunity to build wealth over time. So how does purchasing a home help you build wealth? And what steps should you take to maximize the potential of your investment?
Find out how to harness the power of home equity for a secure financial future.
What Is Home Equity?
Home equity is the difference between what your home is worth and the amount you owe on your mortgage. So, for example, if your home would currently sell for $250,000, and the remaining balance on your mortgage is $200,000, then you have $50,000 in home equity:
$250,000 (Home’s Market Value) - $200,000 (Mortgage Balance) = $50,000 (Home Equity)
The equity in your home is considered a non-liquid asset. It’s your money; and it can provide you with a down payment for you to invest in another property.
How Does Home Equity Build Wealth?
When you factor in the potential of appreciation, an investment in real estate will likely offer a better return than any savings account available today.
A mortgage payment is a type of “forced savings” for home buyers. When you make a mortgage payment each month, a portion of the money goes towards interest on your loan, and the remaining part goes towards paying off your principal, or loan balance. That means the amount of money you owe the bank is reduced every month. As your loan balance goes down, your home equity goes up.
Additionally, the value of your home generally increases, or appreciates, over time. For example, when you pay off your car loan after five or seven years, you will own it outright but the car will be worth much less than when you bought it. However, when you purchase a home, its value typically rises over time. So when you sell it, not only will you have grown your equity through your monthly mortgage payments, but in most cases, your home’s market value will be higher than what you originally paid. Even if you only put down 10% at the time of purchase—or pay off just a small portion of your mortgage—you get to keep 100% of the property’s appreciated value. That’s the wealth-building power of real estate.
What Can I Do To Grow My Home’s Equity Faster?
Now that you understand the benefits of building equity, find out how you can increase the equity in your home:
1) Pay down your mortgage
Paying down your mortgage is one way to increase the equity in your home.
By adding a little extra to your payment each month, making one additional mortgage payment per year, or making a lump-sum payment when an extra money becomes available, your home’s equity will go up and your mortgage balance will go down.
Before making any extra payments, however, be sure to check with your mortgage lender about the specific terms of your loan. Some mortgages have prepayment penalties. And it’s important to ensure that if you do make additional payments, the money will be applied to your loan principal.
2) Decrease your amortization period
Another option to pay off your mortgage faster is to decrease your amortization period. For example, if you can afford the larger monthly payments, you might consider refinancing from a 30-year or 25-year mortgage to a 15-year mortgage. Not only will you grow your home equity faster, but you could also save a bundle in interest over the life of your loan.
3) Raise your home’s market value
Boosting the market value of your property is another way to grow your home equity. While many factors that contribute to your property’s appreciation are out of your control (e.g. demographic trends or the strength of the economy) there are things you can do to increase what it’s worth. For example, many homeowners enjoy do-it-yourself projects that can add value at a relatively low cost. Others choose to invest in larger, strategic upgrades. Keep in mind, you won’t necessarily get back every dollar you invest in your home.
Of course, keeping up with routine maintenance is the most important thing you can do to protect your property’s value. Neglecting to maintain your home’s structure and systems could have a negative impact on its value—therefore reducing your home equity. So be sure to stay on top of recommended maintenance and repairs.
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