Home equity is the value of your home less the amount still owed on your mortgage loan. Building home equity increases your ownership in the property, which helps you enhance your buying power and accrue wealth. You should also be familiar with the term “net worth” ― this is the sum of your assets minus the sum of your debt obligations. Unless you’re lucky enough to win the Lottery, building home equity is a good way to improve your net worth.
How does someone go about building home equity? There are many ways that you can build home equity ― some actions can be taken prior to mortgage closing and other methods can be employed further down the road.
There are several things you can do during the homebuying process to ensure your home equity. If you can afford a large down payment (which decreases the principal balance of your loan) you will be starting out with a substantial amount of home equity. Negotiating with the mortgage lender to secure the best interest rate and loan terms are also crucial at this stage. Additionally, locating or building a home that is marketable to a wide variety of homebuyers means that your home’s value will be more likely to appreciate over time. (A “marketable home” is one that appeals to the majority of potential homebuyers ― this typically entails houses that are cable-ready, with at least 3 bedrooms, 2 bathrooms, a garage, backyard or patio space, and central heating/air.)
When evaluating home equity, you should consider how much sweat equity you’re willing to put into your house. You may have heard of a company called Jim Walter Homes (1946-2009) which was started by the man Jim Walter. Walter established a home-building system that allowed homebuyers to complete the interiors of their houses using materials they could purchase from Jim Walter Homes. This gave people the opportunity to build home equity faster than if they had purchased a finished house. The typical repayment period for Jim Walter Homes was around 20 years, compared to many home loans which take 30 years.
Building home equity and increasing a home’s value through improvements has become more and more popular in the last few decades, as evidenced by the success of home improvement stores across the country. You may also consider obtaining a home improvement loan to have the cost of improvements rolled into your loan balance. The National Association of Realtors (NAR) periodically polls the buying public to determine which features have the greatest influence on homebuying decisions. The biggest change between 2004 and 2007 was the desire for 2-car garages. Other desired features include backyard play areas (for children and/or pets) and energy efficient upgrades.
Some additional ways you can build home equity include the following:
- Provide a high initial down payment on the property.
- Secure a shorter loan term (to reduce interest payments).
- Make extra payments towards principal if/when possible (also called prepayment).
- Take part in community affairs that could affect zoning or the market value of your home.
- Upgrade outdated features (such as fixtures, appliances, and flooring) especially in the kitchen and bath areas, and maintain the quality of your upgrades.
- Consider establishing a covenant or set of deed restrictions with other members of your neighborhood. This can help protect the value of everyone’s home.