One of the biggest advantages of owning your own home instead of renting is the ability to build equity with it. From the initial down payment to your monthly mortgage checks, every dollar you put toward paying off your home grows your home equity. Why is home equity important? Because you may need to tap into that equity someday to cover a major cost - college tuition, credit card debt, medical bills, etc. Here’s what you need to know about home equity and two ways you can help grow it.
What Is Home Equity?
Put simply, home equity is the difference between what your home is worth (its market value) and what you’ve already paid into it.
Market Value - What You Owe = Home Equity
For example, if your home has a market value of $500,000 and you owe $350,000 on it still, that means you have $150,000 in home equity.
Boosting Your Home’s Equity
Every time you make a payment on your house, your home equity increases. And every time your home’s value rises so does your equity. With that being said, there are primarily two ways to increase your home equity: increase your home’s value or pay down your mortgage.
Increasing Your Home’s Value
If you’re looking to boost your home equity and improve your day-to-day living, renovating or adding to your home could be the answer. Making smart home improvements or increasing the square footage are effective ways to increase the value of your home. Major renovations such as kitchen remodels, bathroom updates and the addition of office or bedroom space can add significant value to your home.
Making Additional Mortgage Payments
Adding payments towards the principal of your home loan may get the balance down quicker, save you on interest - and, in turn, increase your home equity. But payments may be limited based on your mortgage type and payment plan. With an open mortgage, you can freely place payments towards your principal at the cost of a higher interest rate. With a closed mortgage, the amount you can pay toward your principal is limited and fineable (if the limit is exceeded), but you will have a lower interest rate. Accelerated payments are also an option, allowing you to pay in varying intervals over a month rather than monthly. However, the overall cost of an accelerated plan is higher.
Depending on your mortgage type, If you experience a sudden or unexpected windfall (such as a bonus at work or lottery winnings), you could choose to put a chunk of that toward your mortgage payment. Alternatively, you could choose to bump up your monthly mortgage payments. Just be sure, however, that you are still able to address your other financial obligations and needs - paying down debt, covering other fixed expenses and regularly contributing to your emergency fund.
Alternatively, you could choose to adjust your amortization period, choosing to repay your mortgage over 20-years instead of the traditional 25 years may pay down the loan's principal faster, causing your equity to accrue more quickly. However, if you choose to do this, it’s important to account for any associated costs and penalties that come with refinancing.
Whether or not you could make a large down payment, there are still ways to build equity in your home. Building equity is an important part of protecting your investment, and it provides you with a safety net should you need to borrow against it in the future.
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