For most families, buying a home will be the biggest financial commitment they ever make. Owning your home offers a number of advantages. In addition to having pride in your home ownership, you receive a number of tax advantages. Most importantly, you have equity in your home, which can be used for other purposes.
Home equity is the portion of your home value that you actually own. When you buy any property, you have to make a down payment to secure a mortgage, usually 20% of the property value, although first-time homeowners can pay considerably less. For example, if you purchase a home valued at $250,000 with 20% down, then your home equity is $50,000.
Of course, with a mortgage, your home equity will increase over time. As you continue to make mortgage payments, the equity slowly increases until you pay off the mortgage. However, most mortgages have 30-year terms, which means building equity can be a slow process, especially since most home loans are structured so you pay more interest at the outset and pay down the principal over time.
Few homeowners keep their homes for the full term of their mortgage. These days, homeowners are staying in their homes for an average of nine years, which is far short of the 30 years it takes to pay off most mortgages. In order to buy a better home, especially as home prices continue to rise, you want to maximize your equity at the time you sell. Building home equity also can be invaluable if you need collateral for home improvements or other large expenses.
There are only two ways to increase your home equity—increase the value of the property or reduce the amount of your debt. Your home will likely increase in value since the average home appreciates 3-5% each year. However, there are proactive steps you can take to both increase your property value and reduce your mortgage debt:
1. Make home improvements: You may not have control over the price of homes in your neighborhood, but you can make your home stand out and increase your property value at the same time. Upgrading your home can increase its value, but you have to be aware of how specific types of improvements affect sale value. For example, upgrading the kitchen, making the home more energy efficient, or adding a bathroom can increase home value. Expensive landscaping or high-end appliances won’t add value. You might consider using your home equity for a home improvement loan to make improvements that will yield greater returns when you sell.
2. Home maintenance: Even if you don’t want to make home improvements, you should be sure to maintain your property. Be sure to repair leaky roofs, faulty plumbing, and outdated water heaters and address other maintenance issues as they arise. Deferred maintenance will cost more in the end.
3. Shorter loan terms: If you shorten the terms of your mortgage, you can reduce your debt faster. Instead of a 30-year loan, consider a 15- or 20-year mortgage. Not only will you increase the equity in your home faster, but you will also reduce the amount of interest you pay over the life of the loan.
4. Make extra payments: The structure of most mortgages allows you to pay down the principal with additional payments. If you come into extra cash or want to increase your home equity faster, you always can make additional payments on the principal.
5. Restructure your household budget: If you want to build home equity in a hurry, then you might consider restructuring your budget so you can apply more money to the mortgage. A strategy many two-income couples use is to allocate one paycheck for the mortgage and the other for the rest of their home expenses in order to pay off the mortgage sooner.
6. Stay the course: If you have a long-term financial plan, then you may choose to do nothing at all. Unless you get an incredible loan rate, refinancing your mortgage or taking on a second mortgage will just delay paying down the debt. Every time you refinance, you have to start building home equity all over again. If you do need to borrow, borrow only what you need and try a personal loan or other strategy that won’t affect your home equity.
Some people consider their home like a savings account; they keep putting money in, and it continues to appreciate in value. However, like any savings strategy, it will continue to increase only if you don’t spend it. The more you can do to improve your home equity, the more you will have available when you really need it.
If you need help reviewing your financial options and developing strategies to get the most from your home equity, the financial experts at iQ Credit Union are always available. Please contact us to see how we can help.
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