One of the biggest perks to owning a home is that it almost always appreciates in value. While the market can certainly dip from time to time, the long-term, historical trajectory of real estate values shows that homes go up in price. Thus, any time you hang on to a property for a few years, there’s an expectation that you’ll build equity. The question is, how can you build more equity, faster?
What is Equity?
Most people say that they’re homeowners when they’re really just partial homeowners. If you buy a house with five percent down on a 30-year mortgage, you technically only own a small fraction of the house. It’ll be three decades before you own the whole thing.
Equity refers to the amount of the home that you actually own after accounting for all debt. To calculate your equity, you simply take the market value of your home and subtract any debt you have on it. If the number is negative, you’re actually underwater. This means you owe more on the house than it’s worth. If the number is positive, this is the amount of equity you have to your name.
Example 1: Your home is worth $400,000 and you have a remaining mortgage balance of $225,000. You take $400,000 minus $225,000 and you’re left with $175,000 in equity. If you were to sell your home and pay off your mortgage debt, this is the amount of money you’d get in return for the transaction.
Example 2: Your home is worth $275,000 and you have both a first and second mortgage on the property. The first mortgage has a remaining balance of $200,000. The second mortgage has a balance of $80,0000. To calculate your equity, you take $275,000 and subtract $280,000 (the sum of all debt). This leaves you with -$5,000. In other words, you have negative equity. This means you’ll actually owe the bank money if you sell the property.
The 2 Ways to Build Equity
Building equity is one of the primary benefits of homeownership. In fact, if you speak with the majority of wealthy people, you’ll find that they accumulated a significant amount of their net worth via their primary residences.
You might assume that equity is built by patiently waiting on the market to ripen, but this is just one small aspect of it. You have more control and influence than you realize.
There are two ways to build equity:
- The property value increases
- Your debt decreases
If you want to speed up the process of building equity, you can’t be passive. You have to proactively attack each side of the equation. In this article, we’ll discuss some techniques and strategies for both.
Increase Your Property Value
There’s a practical, hands-on side to building equity and a financial side. If you’re more of a hammer-and-nail kind of person, you’ll enjoy the challenge of increasing property value. Here are three simple ways this happens:
- If you’re fortunate enough to be in a desirable location, your property value will increase over time. (And if you combine a desirable location with a hot market – like the one we’ve been in for the past few years – your home can appreciate fast!) The average long-term real estate appreciation rate is right around 3 percent per year. However, it’s not uncommon to see gains of 5 to 10 percent in bull markets. When you compound these gains over many years, you can pick up tens of thousands of dollars in additional equity – simply for buying and holding the property.
- Maintenance and repairs. It isn’t sexy, but maintenance and repairs are necessary in order to maintain the value of your property. A failure to address wood rot, leaks, foundation damage, or deteriorating siding could lead to serious and expensive problems that eat away at your equity when it comes time to sell. Stay on top of these things!
- Home improvements. The most proactive way to increase your equity is to invest in home improvements that are most likely to generate a positive return on investment. This includes projects like kitchen remodels, fresh paint, improvements to curb appeal, and other cosmetic updates. If you’re willing to make a larger investment – and it makes sense within the context of your existing home and the surrounding neighborhood – adding on an extra bedroom, bathroom, or flex space could also increase the value.
Reduce Your Debt
Don’t know the difference between a 2×4 and a 2×6? You can still increase property value, but you’re probably better suited for grabbing a calculator, reviewing your budget, and looking for ways to accelerate debt reduction. Here are some things to think about:
- Larger down payment. When it comes to buying a house, the larger your initial down payment, the more equity you instantly gain. If you put down $50,000, you have $50,000 in immediate equity. If you only put down $25,000, then your equity is cut in half.
- Shorter terms. Want to build equity faster? Take out a 15-year mortgage instead of a 30-year mortgage. You’ll build equity twice as fast and will owe far less in interest over the life of the loan. (It should be noted, however, that you’ll have larger monthly payments.)
- Larger monthly payments. Some people choose to take out a 30-year mortgage, but pay it down like a 15-year mortgage. You’re more than welcome to do this. Just make sure you add the extra payment to the “principal” portion of the mortgage.
- Extra payments. Another strategy is to pay your mortgage every two weeks (as opposed to once a month). Doing so allows you to make one extra payment over the course of a year. It’ll feel like dropping a penny into a bucket at the time, but the extra payments add up over five or 10 years. This alone can save you thousands of dollars in interest.
Contact Green Residential
At Green Residential, we’ve proudly served Houston-area homeowners for more than three decades. Whether it’s managing investment properties for our clients, or helping them buy and sell their homes, we have skilled and experienced professionals who are ready to handle any and all of your needs. For more information, please don’t hesitate to contact us today!