December 9th, 2014
There are two ways to build equity, or ownership, in your home. One is to pay what you owe your lender which reduces the principle owed on your mortgage, and the other is to take advantage of market upswings which increase the value of your home. One way to build equity is to put more money down on the home you want to buy. Lenders have returned to tried and true models of income-to-debt ratios, requiring that borrowers put more money down when they purchase a home. While it’s still possible to get zero-down loans, such as those offered by the VA, most loans with low down payments require mortgage insurance.
For a conventional loan, one eligible for purchase on the secondary market by Fannie Mae or Freddie Mac, requirements are stricter, but there is also more leeway on eligibility. The minimum down payment required is as little as 3% to 5%, under special circumstances, including excellent credit and the willingness to pay private mortgage insurance. But to make sure the loan goes through, most borrowers are putting down as much as 20%.
The more you put down, the more equity you will instantly have. This is important because you need equity in order to sell your home one day so you don’t need to come up with additional cash at settlement.
As you make your house payments, you build equity slowly. The longer you own your home, the less you’ll pay in interest and a greater share will go toward ownership, or building equity.
For example, if you borrow $250,000 at 5%, your monthly payment is $1,342.05. Over 30 years, you’ll pay an additional $233,139 in interest for a total of $483,139.
The first month of paying your mortgage, you’ll pay $1041.67 in interest, and only $300.39 toward reducing your principal. At that rate, building equity may seem like it will take forever. But only two years later, your interest payment lowers to $1011.52 and $330.53 goes toward reducing what you owe your lender.
In five years, $383.91 goes toward reducing principal. To learn more, you can go online and look for mortgage calculators with amortization.
You can build equity faster by adding a little more to your payment, which can remove hundreds of dollars in interest from your payments and allows you to own your home in full much faster. You don’t have to refinance to do this — simply allow more to be deducted from your checking account to be applied to principle, or add an additional payment onto your payment coupon.
The second way to build equity is to allow the market to do it for you. Home values historically beat inflation by one to two percentage points, but the last decade has been anything but typical. However, all markets return to the norm, so assuming a normal market is on the way, your home should appreciate at least one percent annually.
If you purchased your home for $300,000, (hence the $250,000 mortgage), your home’s value should grow $3000 in one year. The next year, your $303,000 home is worth $306,030, and so on. This is all providing that your home’s condition remains exemplary, the jobs outlook continues to be positive, and other market variables go your way.
But one thing is certain, you can’t build equity unless you’re invested. If you want to take advantage of the recovering housing market to build equity, it’s time to invest in a home.