It’s been said that owning your own home is one of the biggest steps you can take to build your wealth. Real estate isn’t just about having somewhere to live in the present — it’s also about investing in your financial future.
When it comes to building wealth through real estate, one of the most important concepts to understand is home equity. Let’s explore the crucial topic of home equity — what it means, how you can build it, and what advantages it offers homeowners in the long-term.
Understanding Home Equity
Put simply, an owner’s equity is their interest in their home. You might think of home equity as the amount of a home’s value that you own, and which is not held by your mortgage lender or bank as an outstanding loan.
One way to illustrate equity is with an example. Let’s say that a buyer purchases a $300,000 home with a 20 percent downpayment ($60,000), and takes a loan for the remaining $240,000. In this case, the new homeowner’s immediate equity would be the 20 percent they paid, or $60,000. This is the dollar value amount of the home that they truly “own,” so to speak; their bank or mortgage company owns the rest.
An easy calculation to determine your equity is to subtract your loan balance from the value of your home. So, let’s say that as time goes on, our homeowner pays enough that they now only owe $100,000 on their loan. That would make their equity in the home $200,000.
Now, over that same period, it’s important to keep in mind that the value of the home is going to change, as market factors drive home prices up or down. This will also affect the amount of equity that the homeowner has. So, if the value of the home were to appreciate significantly, our homeowner’s equity would increase as well. If the value of the home doubled, for example, our homeowner’s equity would actually now be roughly $500,000, on their $600,000 home.
How to Build Home Equity
Broadly speaking, the more equity a homeowner has in their property, the better. So, what does it take to build equity? Generally, there are two primary ways for homeowners to develop equity:
- The homeowner pays down their loan and decreases the amount of debt they owe
- The value of the home appreciates with time
Now, in both of those situations, there are both active and passive ways for homeowners to help build their equity.
When it comes to decreasing their debt, homeowners have a few options. The passive method is for homeowners to continue to make their monthly mortgage payments on time. With most standard amortized home loans, over time, each payment you make increasingly goes toward the principal on your loan, rather than the interest — meaning that, in time, you are contributing more and more to your equity, while making the same basic payment each period.
There are also steps that homeowners can take to be more proactive, and decrease their debt more quickly. For instance, homeowners can typically pay extra each month, with the money they contribute beyond their necessary payment helping to pay down their principal sooner. In other cases, home buyers who want to build equity more quickly might even want to opt for shorter terms on their loan. For instance, you’ll typically build equity faster with a 15-year fixed-rate mortgage, compared to a 30-year loan.
Changes in Property Value
Homeowners also build equity when the value of their property increases. The passive method is to allow market factors to drive your home’s value up over time.
An important thing to remember? As writer Hal Bundrick points out for consumer information site NerdWallet, “building home equity is a slow climb,” in most cases. As he notes, U.S. residential year-over-year home price appreciation averaged 1.89 percent from 1997 to 2017; over that same period, there were major positive and negative price swings as well, ranging from a gain of 12.6 percent to a drop of roughly 18 percent.
In other cases, homeowners may be able to take some active steps to increase the value of their home. For instance, performing certain home improvement projects with a high rate of return on investment (ROI) may help you bring up the value of your property — though this will certainly take an investment of capital upfront, and an increased home value from renovations or updates can be hard to guarantee.
In some cases, performing updates and maintenance may be what it takes to maintain the value of your home on the market; allowing your property to deteriorate could decrease your home value, and decrease your equity.
The Benefits of Building Equity
Building equity in your home can be an effective way to increase your wealth in the long-term.
Owning a home is truly an investment. Home payments are sometimes called “forced savings,” for this very reason. While you’re making payments every month, you’re also helping to increase the value of your investment asset, your home. You’re building your wealth over time, with each and every payment you make.
This long-term value is why home equity is so important. In essence, home equity is a financial asset, which homeowners can use in many different ways. With the right strategy in place, you can use the equity in your home to purchase your next property when it’s time to move. In some cases, you can use home equity to help fund your retirement, or to pass on your wealth to your heirs.
And, in other cases, home equity can act as an asset for you to borrow against. Home equity loans often offer lower interest rates and tax advantages, compared to some other types of loans. There are also different ways to access the funds from your home equity, including taking a loan as a lump sum payment, or opening a home equity line of credit (HELOC). Before taking any loan or opening a line of credit, it’s important to be sure to do your research, and understand your potential fees, interest rates, and repayment terms. Remember that when you borrow against your equity, you’re putting up your home as collateral.
Baird & Warner Makes Owning Easier
Buying a home is one of the biggest personal and financial decisions most of us will ever make. It’s important to have a team on your side that understands everything that goes into purchasing and owning a home.
Here at Baird & Warner, easier is who we are. Finding easier ways to turn the American dream of home ownership into a reality has been part of our DNA from the start, and guides us into the future.
With 30 local offices and thousands of highly skilled agents all around Chicagoland, we’re replacing uncertainty, confusion, and anxiety with excitement, confidence, and peace of mind.