A Beginner’s Guide to Building Equity

Building equity is one of the most important parts of homeownership. Equity refers to the portion of a home’s value that isn’t under a mortgage. Building this up means the homeowner is reducing what they owe and building more value into the home.

Understanding a Home’s Equity

It is always important to understand that the sooner the loan is paid off, the less the homeowner will spend to purchase it. More so, when the owner increases the amount of equity present, it is also creating a new way to borrow later on that offers lower interest rates and easier qualifications.

Here is an example. Assume a person buys a home for $200,000. They have been paying the balance for a while. Now, they owe about $160,000 on the property. In this example, the owner has about $40,000 worth of equity – the portion of value for the home that is not under a loan. The higher this is, the more borrowing power they have if you need down the road.

The question is, though, how does a homeowner build equity? The faster they build equity, the better. These strategies can help do that faster.

#1: Make a Big Down Payment

The best way to have fast equity in a home is simply to not finance the home for its total value.  The home buyer can do this with a larger down payment. Consider a home valued at $200,000 for purchase. A buyer makes a down payment of $20,000 on the property. This means the buyer needs a loan of about $180,000 to purchase the home. It also means they have $20,000 in nearly instant equity in that property.

Down payments are a requirement for many mortgage loans. Some lenders require up to 20 percent of the home’s purchase price as equity. Others have just a 3 to 5 percent down payment requirement. Whenever a buyer invests in a down payment that is substantial, they are building equity into their purchase.

#2: Make Aggressive Monthly Payments

Every home loan has a very specific payment schedule. The mortgage loan agrees to specific terms. This includes a portion applied to principle and a portion applied to interest. The larger the principal component is, the faster equity builds. There are a few things to remember here.

When making additional payments, ensure the lender applies those additional payments directly to the principal owed. The principle is the amount of debt owed to the lender on the loan. The interest will continue to build based on the value of the principle. By paying more than what is owed towards the principle, two things occur:

• The principle falls, meaning more equity is built up in the home
• With a lower principle value, less interest is applied to the loan, saving the home buyer money over the long term

To do this, most homeowners need to set up payments to apply an additional amount towards the principal specifically. Most mortgage lenders allow for this. Any additional amount is worthwhile, with the largest amount possible, increasing equity faster.

#3: Pay Every Other Week Instead of Monthly

Another way to build equity quickly is to set up payments to pay every other week. Most lenders allow bi-weekly payments of half of what is owed for the month. In the above example, the homeowner would pay $500 every other week instead of paying $1000 each month. The first payment goes into a type of reserve account until the second payment is made. Then, both payments are applied to the loan.

The benefit of this is that it allows for a full extra payment to be made each year. There are 52 weeks in a year, which means property owners will make 26 bi-weekly payments. This is the equivalent of 13 monthly payments. By paying like this, equity rises faster because an extra payment is made each year.

It is one of the easiest ways for a property owner to increase what he or she is paying without feeling the financial pinch. Most property owners find it is easier to budget for bi-weekly payments than one large monthly payment as well.

#4: Make Big Payments Whenever Possible

Throughout the year, many people receive a chunk of extra money beyond what they may receive in traditional monthly payments from income. Any time this type of extra month is available, put it towards the principal owed on the loan.

One example is a tax refund. If a property owner receives a tax return of $2000, he or she can apply this as an extra payment on their mortgage. Make sure it applies directly to the principal owed. That reduces what is owed immediately and increases equity right away.

Any other extra payments can be applied in this way. That may include bonuses from work, commissions checks, payments from friends or family, or any other amount. The sooner the principle on the loan is paid down, the more equity is present, and the less interest is paid out.

#5: Work to Add Home Value with Additions

One of the biggest impacts on equity comes from building up the value of the home. This can be done in many ways, but for a significant increase, consider the value of adding a home addition to the property. Additions, such as adding a new bedroom, expanding the living space, or otherwise adding square footage, will drastically increase the value of the home.

Not every dollar spent on a home addition will directly impact the value. However, it will make an impact. For example, a property owner may spend $25,000 to add a new bedroom to the home by expanding the footprint of the property. In doing so, this may add $20,000 worth of value to the home, or more.

With large-scale investments like this, quality matters. Any investment made in this manner should be done by a licensed professional. It should also be done according to local building codes to reduce the risk of problems down the road.

#6: Consider Refinancing to a Shorter Term

Another way to improve equity may be to refinance the existing home loan. There are a few limitations to this. Refinancing does come with closing costs – which must be considered to determine if the value of the home and available interest rates work here. However, refinancing should be to reduce the term or length of the loan, specifically.

The longer it takes to pay down a loan, the more expensive it is. That is because interest has a longer period to apply to the loan. It also is because long-term loans tend to have lower monthly payments. The lower the monthly payment, the less money is being applied towards that principle.

By refinancing to a shorter loan period, if financially wise, it is possible to force a person to make larger payments on a loan. In other words, property owners are paying more each month towards the principal.

Here is an example. A home buyer purchases a home with a mortgage valued at $200,000. It has an interest rate of four percent. The mortgage has a 30-year term. The monthly payment here is $955. In total, the principal borrowed ($200,000) plus the cost of interest $(143,739) will mean the homeowner pays a total of $343,739 to buy this home.

By comparison, if the property owner obtains the same loan and interest rate, but secures a 15-year term, that figure drops significantly. Now, the monthly payment is higher at $1479. However, the total cost of the loan is the principal ($200,000) plus interest ($66,288) for a total of $266,288. That is a total savings of $77,451 for the property owner.

Each payment is paying more towards the principal each month, too, which is increasing equity at a faster rate. That means they can borrow from their equity sooner in most cases. Keep in mind that to do this, the home buyer needs to be able to afford the significantly higher monthly payment. If so, a shorter term is always the better route to go.

#7: Increase Exterior Home Value

Adding value to a home is a good way to increase equity in a property. There are many ways to do this from the exterior of the home. Improving curb appeal, for example, makes homes more desirable to buyers. Ultimately, the value of a home is dependent on what a buyer will pay for it. By driving up that curb appeal, it is possible to increase the value of the property.

Every property should consider an update to the exterior based on areas of need or concern. Here are a few key methods of doing this.

• Clean up and modernize the landscaping, especially trees and shrubs. Neat and well-cared for plants tend to drive up the value of a property by enhancing the perceived value of the home.
• Clean the siding or update it. Siding that is in good condition ensures the home’s exterior is protected.
• Update the roof with energy-efficient roofing materials. Some products are also designed to minimize the energy loss within the home. Improving the roof is a good way to boost the value of the home, especially if the roof requires repairs.
• Add functional outdoor storage. A professionally built shed or garage, for example, can drive up the value of the property. A workspace or workshop can also add value when built professionally.
• Reduce risk factors. If a homeowner is considering refinancing or a home equity loan, remove factors that reduce the value, too. This may include pools, trampolines, or outbuildings in poor condition.

Finding ways to enhance the exterior of the property is a good way to build equity as long as it improves the aesthetics, structural integrity, or functionality of the property. It is a good idea to get an estimate of the value of these upgrades as they happen.

#8: Increase the Interior’s Value

There are many ways to increase the interior value of a home, as well. The key is to look for any obstacles that can limit the value of the home and to focus on these first. Here are some key areas to focus on first.

• Increase the number of bedrooms and bathrooms. Adding any of these – in a professional manner – can drive up the value of the home. Homes with three or more bedrooms and 2 or more bathrooms tend to be valued significantly higher even if they have smaller square footage.
• Modernize the kitchen. Kitchens are often the center of the home but can age quickly.  A modern kitchen will build the home’s value up, especially if the work is done professionally.
• Open up the floor plan. A closed-in floor plan tends to have less functional space. Getting rid of unnecessary walls can help to open up spaces to create an open floor plan.

Updating paint, appliances, bathrooms, and bedrooms are also good ways to increase value. Finishing the basement and adding specialized areas can also help improve value.

#9: Hold Onto Property Longer

Another important way to drive up the value of the property is to just hold onto it. Real estate values increase over time in most cases. While there can be sudden drops in value, in the long term, real estate is one of the best investment strategies to have. Most property owners will find just owning their home long term will increase the value of it.

It is possible to learn more about the rate of real estate value increase by speaking to a local real estate agent. In some cases, this may be as much as 2 to 4 percent of the home’s value increasing annually, especially in markets with few homes for sale or with a significant amount of people wanting to buy into that area.

The goal of building equity is twofold. Work to pay down what is owed on the mortgage for the home as quickly as possible. At the same time, work to increase the value of the home if it was sold on the market today. This allows for fast, reliable equity building.