For many people, a home purchase is not only a place to live and put down roots but also their biggest asset. You could think of a mortgage as a forced savings plan. Every payment you make deposits more money in the home. So long as the home's value keeps climbing, so does your savings.
The home is many people's single biggest retirement plan too, either as a place to live mortgage-free after the home is paid off, or as a source of income after selling and downsizing.
Equity is the difference between your home's market value and what you owe.
Think of "value" and "owe" as two dials: turn the Value dial up or the Owe dial down—or better yet, turn both—and you increase equity. What's great about home ownership as an investment is that the Value dial tends to turn up on its own thanks to appreciation, and as you make the monthly mortgage payments the Owe dial turns down too. Equity grows, but is it growing fast enough for you? What can you do to crank one dial or the other, or both?
Here are four tried and true ways that homeowners build equity faster.
A Big Down Payment
Making a large down payment establishes your equity in the home immediately. Instantly you own more and owe less. If you can swing a down payment of 20%, you build equity even faster because more of your monthly payment can go toward the home itself (the loan principal) and not toward private mortgage insurance (PMI). Lenders require PMI on mortgages with down payments under 20%. This insurance covers the lender but is paid for by the homeowner. That's money that could go toward the principal instead and thus build equity faster.
The average down payment for a newly built home in 2019 was 6%, according to Forbes.
A 15-Year Mortgage
The 30-year fixed-rate mortgage is the most popular, but cutting the term to 15 years yields big savings in interest while accelerating equity. Your monthly payment is higher for sure, but contrary to what you might expect, it's not double the payment you'd make for a 30-year mortgage. Your payment will be around 33% higher with a 15-year term compared to a 30, as you can see from the table below.
A 15-year mortgage gets you to the finish line—100% equity—in half the time, and you saved huge money on interest. For example, if you finance a home for $200,000 at 4% interest over 15 years, you’ll pay $66,288 in interest. However, if you finance a home for the same amount with the same interest rate for 30 years, you’ll pay a whopping $143,739. The savings is so substantial with a 15-year mortgage that home buyer would do well to consider buying a less expensive home so they can manage higher payments and build full equity in just 15 years.
Pay More Principal Each Month
Adding as little as $100 to your payment each month can significantly improve your home loan's bottom line (see table below). After only five years you will have paid down the mortgage by an extra $6,000. See the table below for the surprising amount of money an extra $100 saves on interest and the years that it shaves off the loan.
Rather than $100 a month, another approach is to make an extra payment every year, or the equivalent. You could use an annual bonus or other windfall, but another strategy is to pay one-twelfth extra each month. At the end of each year, you will have made the equivalent of 13 payments.
Another way to make 13 payments a year takes less effort. Just pay your mortgage biweekly if your lender allows it. Paying every two weeks is the equivalent of 13 monthly payments.
Whichever method you use to pay a little extra each month, ask your lender how you can ensure that the extra goes 100% toward the loan principal, not the interest. Examine your monthly statements to make sure it happens. Only the money you pay toward the home builds equity. Don't let the bank divert any of that money to its own pockets.
Paying down the principal sooner dramatically cuts the amount of interest you pay over the life of the loan.
Remember that equity is the difference between the home's market value and how much you owe on it. So far we have talked about turning down the Owe dial quicker, but what about turning up the Value dial?
Best bang-for-the-buck summer home improvements
You have little control over home values in your neighborhood or town, much less the local and national economies, but you do control your home improvements. Consider these minor home improvement projects to add value to your home and thus build equity without the expense or hassle of major renovations.
- Improve curb appeal. An investment in fresh paint, fixing broken roof tiles, landscaping, and upgrading other features of your home's exterior typically brings a 100% return.
- Minor bathroom upgrade. Recaulk and glaze the bathtub, replace the toilet, repaint the walls, or swap out carpet for hard flooring. Little improvements in the john can raise home value a lot.
- Kitchen facelift. Stick to minor improvements like refaced cabinets and new appliances to see the biggest return on investment. The sledgehammer renovations that make for such good TV are an ordeal for homeowners.
- Add living space outdoors. Tricking out a patio with a firepit and more seating is a cost-effective means of adding living space. Same with building a wooden deck. It is estimated that you can expect a 75% return on investment when you build a deck.
- Equity is your home's value minus what you owe on it.
- Ways to quickly lower what you owe include a larger down payment, paying a bit extra each month, and opting for a 15-year term.
- A way to quickly increase value is to make smart home improvement.