Building equity is one of the main ways homeownership helps individuals build wealth. But what is equity really and how do you build it? Read on to learn what equity is, how it builds, and how it can help increase wealth.
What is Equity?
Quite simply, equity is the difference between what you owe on your mortgage and the current value of your home. So, if you owe $200,000 on your mortgage and your home is currently valued at $300,000 your home has $100,000 in equity. (Don't know your home's current value? Request a FREE home property report to find out!)
How Do You Build Equity?
Your equity can increase in two ways:
1) You pay down your mortgage.
2) Your property appreciates (meaning it increases in value)
In most markets, you are both paying down your mortgage and property values are appreciating, so both of these components are working hand in hand to increase your equity. In the United States, the conservative average for property appreciation is 3% to 5% each year. From September 2019 to September 2020, the average appreciation rate in the U.S. was 6.7%. It is projected to be 8% in 2021. In a rare housing market where property values are depreciating, however, this will have a negative impact on your home's equity.
Once you are a homeowner, there are several things you can do to speed up the rate at which you build equity:
Pay More than the Minimum Monthly Mortgage Amount
Stay in Your Home for Five Years or More
Prioritize Home Projects that Increase Your Property Value
When you pay your mortgage each month, part of the payment is going toward paying off the principal balance of the loan and part will go toward paying off interest, taxes, and insurance. Loan types can vary, but in general the more payments you make the more money will go toward paying off the principal. Once this happens, typically after the third year or so, you will see a jump in equity. Therefore, the longer you stay in your home and the more you can pay down your principal, the more your equity will increase.
You can further speed up this process by being intentional about which home improvement projects you tackle. For example, adding an extra bedroom, as well as kitchen, fireplace, front door, and garage door improvements tend to see good returns when it comes to boosting a property's value. On the other hand, backyard patios, bathroom additions, backup generator additions, and sunrooms are usually the worst projects for seeing a return on your investment reflected in property value. Be sure to do your research before investing money in a home improvement project as the most impactful projects may vary slightly with home type and location. Careful planning and research related to home improvement projects can pay off when it comes to increasing your home's equity.
How Does Equity Build Wealth?
As you pay your mortgage each month you are not exchanging money for a service or commodity, as you do when you pay rent. Rather you are paying into a type of forced-savings account. The equity in your home is not readily available to tap into on a whim, and it typically increases over the years as your property appreciates and you pay down the principal of the loan. In addition, a home is unlike most other assets you purchase with a loan (think car, boat, etc.) because a home generally appreciates over time while the other purchases are generally depreciating assets that decrease in value the longer you own them. The longer you own the home, the more it is generally worth.
ATTOM Data Solutions U.S. Home Equity & Underwater Report found over 17.8 million residential properties in America were considered "equity rich" at the end of the forth quarter of 2020. This means the current amount owed on the property was no more than half the property's current value. That is about 1 in 3 of all residential properties in the United States!
What Can You Do With Your Home's Equity?
Your home's equity can be used in various ways. For many, when they sell one home they will use the equity from that home toward the down payment for an often upgraded, more expensive home.
Other times, individuals will use a cash-out refinance to take out a portion of their home's equity. This money can then be put toward a major home project, tuition expenses, retirement, etc.; whatever major expense the homeowner may need. (If you have questions on a cash-out refinance, our team at O Capital Group is happy to answer them!)
In other cases, a homeowner may be trying to consolidate debt. They may work with a mortgage expert to pay off all their high-interest credit cards and debts and roll this into a much lower interest mortgage loan.
In addition, a financial planner can help you plan the best way for your properties to be gifted upon your death. In this way, your equity has the potential to build not only your wealth but wealth that can be passed down for generations to come. Once you start building equity, there are many ways to use it to make your money work the best for you and your future goals.
What Do I Do Next?
If you are already a homeowner, talking to a mortgage expert will let you know where you stand in terms of equity. A mortgage expert can also listen to your future goals and discuss whether or not a refinance, rate reduction, or cash-out may help you move closer to those goals.
If you are not already a homeowner, talking to a mortgage expert will let you know what steps are needed to turn your homeownership goals into reality. Many people do not realize they may be closer to qualifying for a home loan than they think. In addition, many people working to be homeowners do not realize that purchasing a smaller, starter home may empower them to build the equity needed to use for a subsequent down payment for their dream home. The sooner you share your goals with a trusted mortgage professional, the sooner you will be able to take the steps needed to bring those goals to fruition.
If you are in Arizona, our locally owned team at O Capital Group is here to listen to your goals and answer any questions you may have. Reach out today!
At O Capital Group, we make home loans easy!
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This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.