5 Ways to Build Your Home Equity Faster
As you make your monthly mortgage loan payments, you naturally gain equity in your home. If you pay in full and on time, your equity will grow on its own as your principal loan balance decreases, but you can also help speed up the process. Let’s look at what home equity is, and talk about how you can gain equity in your home faster.
What is home equity?
Home equity is the part of your home that you actually “own.” Every month, you make a mortgage payment, slowly paying down more and more of the loan balance on your home. Meaning if you purchase a home with 20% down, you already have 20% of the home’s value of equity in the home. As you pay off your loan over the years, your payments chip away at your principal loan balance, and you will build more equity. To calculate your home equity, take the current appraised value of your home and subtract the remaining amount you owe.
Why is building equity a good thing?
Let’s say your home appraises for $200,000, but you still owe $60,000 on your loan. If you subtract $60,000 from $200,000, you get your home equity: $140,000. Sounds great, right? But what does that number mean? Building equity is one of the major bonuses of being a home owner. By building equity, your home becomes a valuable asset that you can use down the road. Let’s take that $140,000 worth of equity in the example. This is the amount of money that you could do something with if you sold that home right now. You could use this money to buy a new home, or make another large purchase. Additionally, you could borrow against your equity with a second mortgage loan, often called a home equity loan. Some people look at their home equity as a forced savings account. By making regular mortgage payments you build up the value of your asset, similarly to making deposits into your bank account builds the value of your savings account.
5 ways to build your home equity faster
You can build equity by increasing your property value or decreasing the amount of debt you own. If you make your loan payments in full and on time, you will slowly build equity in your home. However, it’s possible to build your home equity faster.
1. Plan to pay more toward your principal balance
You’ll pay off your over the pre-determined, fixed period of time (usually 15 or 30 years). As you make payments, your principal balance decreases, which is what we’ve already learned is how you build equity. You can increase how quickly you’re gaining home equity by making extra mortgage payments, or paying more than you owe each month. If you make one extra payment a year, you could potentially pay off your loan ahead of schedule. You could also pay $X more than your required payment each month to get ahead. For example, let’s say your monthly mortgage payment is $1,200. $1,200 divided by 12 is $100. If you had $100 to your monthly mortgage payment, you will have made one extra payment after 12 months, shortening the life of your loan and building more equity. Note: Be careful. Some loans have prepayment penalties, and you could be penalized if you pay off too much of your loan ahead of schedule.
2. Use bonus money, gift funds, etc. when you can
This goes hand-in-hand with paying ahead of schedule. If you don’t want to commit to $X more a month or one extra payment a year, just pay extra when you have the funds available. This might be when you get a holiday bonus at work, or when you get your tax returns. Maybe you make it your goal to put any overtime pay you make toward extra mortgage loan payments. Maybe you’re lucky enough to inherit some money. You could also put that toward extra payments. However, when you make extra payments, make sure the money is going toward your principal, not your interest. Talk with your mortgage lender to clarify.
3. Complete home improvement project
From a minor bathroom remodel to a major kitchen renovation, a home improvement project can add significant value to your home and therefore, increase the equity you have in your home. Even an investment of a few hundred dollars could bring a huge return in the home’s value.
4. Choose a 15-year loan rather than a 30-year loan
A common mortgage choice is a 30-year mortgage loan, which means you pay back the loan over a 30-year period, but there is also a 15-year loan term option. You can compare the monthly mortgage payments and costs associated with a 30-year versus a 15-year mortgage with your mortgage lender to see if a 15-year mortgage loan is within your budget.
Just because a 15-year mortgage is half the 30-year loan term, doesn’t mean that your monthly payment necessarily doubles.
It’s not that simple. For example, if your loan amount is $200,000 with 4% interest for 30 years, your monthly payment before private mortgage insurance (PMI) and taxes and any potential HOA fees will be about $955. For that same loan over 15 years, your monthly payment before PMI and taxes and HOA fees will be about $1,479. That’s a difference of $524, which might seem impossible. However, the shorter loan term means you’ll be paying less interest over the life of your loan term with a 15-year loan than with a 30-year loan. Not to mention, you’ll build equity in your home faster with the shorter loan term.
5. Make a big down payment
You may qualify for a loan with no or a low down payment, and while that may be tempting, if you’re looking to build equity faster, it may not be the best choice. To build equity quickly, consider making a large down payment on your home. The more you put down, the more equity you start with. If you put 20% down, you start with 20% of the home’s value of equity in your home. Make sense? An added bonus to putting at least 20% down is that with certain loans, this will mean you can avoid paying for PMI, which can be pricey. Building equity is a huge benefit of homeownership. Over time by making your mortgage payment in full or paying more than you owe, you are building a valuable asset that may help you in the future.