I was having a great conversation with my 18-year-old daughter, Lexie, the other day on our way up to Joplin to see some family. I’m having her read a book by Dave Ramsey and she had questions about all kinds of things and one stood out to me. “Hey, dad, what’s home equity?” I was both excited and proud that at 18 she’s trying to figure these things out about money and investing. I was pounding dirt in the Marine Corps thinking about the next 48 hour “libo” around the corner. And, as a Realtor, I was pumped to share some knowledge with her.
Building equity through homeownership is a great way to increase wealth, but it doesn’t always happen that easily, or very quickly. Let’s dig in a little.
First, home equity is the percentage of your home’s value that you own.
In this blog, we will take a closer look at how to increase your equity without increasing your budget or blowing the budget out altogether. And, potentially how you can access it when you need it.
How to determine how much equity you have
Equity is easy to figure. When you first buy your home and you put 5% down, that’s 5% in equity that you have. If your home appraises for more than the purchase price, then add the difference to the total. So, on a $200,000 home and you put 5% down and the home appraised for $205,000 you have $15,000 in equity.
From 2016 to the first quarter of 2018, most first-time home buyers in the U.S. started with about 7-percent equity, according to Inside Mortgage Finance. This is encouraging because it shows you don’t need to spend years saving for 20 percent down or more before you buy. Repeat home buyers started with more equity, at about 17 percent.
How to build your equity
Here are 6 ways to let your home build wealth for you. Some require time, money, or both. It would also be wise to consult a lender who can help you decide what would work best for you.
1. Home Appreciation
This can take a lot of time, or a little, depending on our market. For the last few years our home values have been on the rise and it’s been great for all of us here in Northwest Arkansas.
I was reading some research on Zillow and they have wrote “that the median home value grew from $185,000 in April 2016 to $216,000 in April 2018.” If you bought a home for $185,000 in April 2016 with a down payment of $12,950, your beginning 7-percent equity would have grown to 23 percent by April 2018.
We calculate this by subtracting your current loan balance ($165,600) from your home’s current value ($216,000). Then we divide the difference by your home’s current value. One-eighth of this additional 16 percent equity is from paying down your mortgage, and the rest is market appreciation.
If you waited two years and bought the same home in April 2018 with a 20-percent down payment of $43,200, you started off with 20-percent equity. You also used 3.3 times more cash to make the purchase. And here’s the kicker: Your total monthly housing costs would be the same, about $1,050 in both cases.
This example illustrates two things:
First, the power of home appreciation. It’s a lot like buying stock and benefitting as its value goes up. But there’s also a difference: While you’ll pay capital gains on rising stock value, you’re exempt from paying taxes on primary-home capital gains up to $250,000, or $500,000 for married couples.
Second, waiting to “save enough” isn’t the primary factor in determining if you can afford to buy a home. When it comes to qualifying for a loan, lenders do indeed look at your down payment. They’ll also want to know how much you’ll have in cash reserves after closing. But there are lots of options for low down payments that require minimal reserves.
There are a lot of factors that a lender will consider for deciding what you can afford on a loan. And debt to income, your monthly bills (or budget), and total income are huge factors that lenders will consider when deciding whether you can afford. And, it will greatly depend on the type of loan program you choose.
Lenders could allow you to spend between 43 percent and 49 percent of your income on monthly bills, which is actually on the high side and could strain your budget.
Since 2016, most first-time buyers have spent about 38 percent of their income on housing and other debt, which is a pretty safe cap for budgeting.
2. Put up as much as you can for the down payment
You can do this but, as we’ve seen, waiting to save extra cash can go against your broader financial interests if you lose the chance to build equity through appreciation. Therefore, you must strike a balance among down payment, monthly budget and savings for other priorities. A good lender can provide rate and market insight to help you do this. Ask me for a list and I’ll email it to you. 🙂
3. Use those Bonuses, Gifts, and Inheritances
Take advantage of work bonuses, family gifts and inheritances to pay down your mortgage (principal). If you choose to pay down in lump sums like this, see if your lender will recalculate your monthly payment based on the new, lower balance.
4. Make biweekly (or more) payments
Make mortgage payments every two weeks instead of once a month. Over the course of a year, this will add up to 13+ monthly payments instead of 12. You’ll build equity faster and shave five to six years off a 30-year mortgage. Just make sure your lender isn’t charging extra for processing semimonthly payments.
5. 15-Year Vs. 30-Year
Take out a 15-year mortgage instead of a 30-year mortgage, and you’ll build equity twice as fast. Two caveats here: You’ll have a significantly higher monthly payment and, because of that, you may have a tougher time qualifying.
6. Make home improvements
New appliances, new french doors, new roof, or cosmetic features like paint are unlikely to increase value (can/will increase the desirability, which can get you a better offer when you list to sell). Only big improvements like new kitchens, or additional bathrooms or other rooms will add meaningful value. Make sure the cost of such improvements will create the added value you’re looking for.
Want to use your equity?
You must borrow from or sell your home to use your equity. The three most well-known ways to get to your equity through borrowing are a home equity line of credit (HELOC), home equity loan or a cash-out refinance. Do some research and write a pros and cons list to compare.
Rates are rising right now so these borrowing options might cost more in the future. Always consult your trusted lender to determine the best approach for you.
12 Stones Realty Group 