Home equity is a financial term often used by our Loan Officers when customers are applying for certain types of loans. If you’re thinking about exploring loan options, you might be wondering what home equity means, and more importantly, how to build it.
Home equity refers to the amount of your home that you actually own, free of debt. If you take out a mortgage, your home equity would be the value of your house, minus the amount that you owe on it (principal plus interest). It typically takes between five to seven years to build up, depending on how fast you are paying down your principal amount.
So why do loan officers ask about equity? Because in some instances, you can use it as an asset to borrow additional money (through a home equity line of credit, or HELOC) when you may need to put a down payment on a new home, or conduct home renovations or repairs.
Generally the more equity you have, the better off you are. If your property values increase, and your debts decrease, it increases your options for borrowing, should you need it.
There are several ways to build home equity, eight of which we’ve listed below:
When buying a home, the larger the down payment that you can make immediately means the larger amount of the home you will own debt-free. This gives you some home equity right away, and reduces the overall amount of debt that you’ll be paying interest on. A larger down payment can also lower your monthly payments and reduce your loan term.
Over time, the more you pay on your mortgage, the more money starts going toward the principal amount, which decreases your debt. When you pay a bit extra on your mortgage payments each month, the amount of interest you are paying goes down, and a larger amount begins to go toward the principal amount.
Helping to increase the overall property value (fair market value) to your home is also a great way to build home equity. Renovations such as building a privacy fence, adding a deck, or finishing a previously unfinished interior space are great ways to do just that. Be mindful of how much it costs you to complete the improvements and approximately how long it will take you to see the rise in value. The one thing you don’t want to do is to invest your money into something that won’t benefit you in the long run!
Updating the curb appeal of your home can even have an impact on home equity. Things such as building a retaining wall, or adding attractive landscaping features around the perimeter of your property are inexpensive ways to help increase the property value of your home.
Making sure that the items inside your home, such as pipes, electricity, and even flooring are kept up-to-date with maintenance will also keep your property values high. When there are a number of items that need fixed all at the same time, you could be losing money by trying to fix them all at once.
When you are obtaining your loan for the first time, selecting a shorter loan will also mean that you are paying larger amounts on your home faster so that you are able to put more into your pocket.
In certain instances if you can save by refinancing, it’s definitely something to talk to your local mortgage officer about. However most of the time in the early life of the loan you are paying mostly interest, which cuts out of making those larger principal payments. Refinancing is essentially starting over toward building home equity.
Appreciation is when the house property value rises naturally on its own, without you having to make improvements. This is the best type of way to build home equity because it doesn’t cost you a dime. Perhaps your neighborhood values are increasing, or you live in an area where the town is expanding and other people want to buy homes, the appreciation of your home could help put extra money in your pocket.