How to Build Home Equity

For many people their home is one of the biggest assets they’ll own. As with any asset the goal is to maximize the value, and your home is no different. This article will look at a number of ways of building home equity with various levels of effort.

Just to make sure we are all on the same page, here is the definition of home equity:

The Home's Current Fair Market Value – Total Amount Owed = Home Equity

How to figure out how much equity your home has and ways to build equity.

Here are a few approaches to building home equity:

  1. Increase the FMV (fair market value) - A great way to increase FMV is by making home improvements.
  2. Reduce the amount owed on the property. Here are a few tips:
    • The natural pay down of the mortgage (given the loan is fully amortized) – By simply making your payments every month you are increasing your home equity. As with an amortized loan, you will be paying more interest and less principal at the start of the loan. So for example, you have a $100,000 loan at an interest rate of 4.125 amortized over 30 years:
      • Year One – total payments for the year = $5,815 of which only $1,723 goes toward principal and $4,092 toward interest
      • Year Fifteen – total payments for the year = $5,815, but now it has flip flopped and $3,066 goes toward principal and $2,748 toward interest
    • Making extra principal payments – If this is something you want to do, I recommend making the extra principal payment “in addition” and separate from the monthly mortgage payment.
    • Make Biweekly mortgage payments – You can make a payment every other week for a total of 26 payments, which is equal to making one more payment a year. In addition, it reduces the total amount of interest paid over the term of the loan. There are programs that will administer this, but they charge an administration fee. My recommendation is to set it up to auto pay biweekly, this way you control the payments and there is no fee.
    • Having a shorter term mortgage – This increases the size of the payments but also helps build equity faster.
    • Refinancing –My recommendation is to only consider refinancing if the interest rate is 1.5 to 2 percentage points less. Also, if you are pulling out cash make sure it’s used for maintenance or improvements to the home – not a new boat or car.
  3. Organic Appreciation – This is an element of which we have little to no control over. If you look at the chart below, you will see that each state has different average appreciation rates over the last 40+ years.
    Stats on the appreciation and depreciation of the housing market.

    This is the average over time; remember there have been and will be times when the market will depreciate – like in 2007-2010. One of the major drivers of value is supply and demand. When we hit a down turn in the economy it will affect demand which in turn will impact values. So, it is best to keep the debt associated with your home as low as possible – this will hopefully allow you to maintain some equity in your home as you ride out whatever market fluctuations there might be.

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