When you’re new to this whole mortgage thing, the vocab can be a bit tricky. Basically, equity refers to the amount of your home that you actually own.
When you first buy a house, your down payment is the only equity you have in your home. The rest the rest of the money you used to pay the seller is the bank’s, which means that the rest of the house is technically the bank’s, too. By building equity via your monthly payments or other means, you increase your share of the house and reduce the bank’s.
Let’s look at an example:
Say the purchase price on your home was $100,000. If you made the standard 20% down payment, then you have $20,000 in equity, while the remaining 80% is the bank’s stake in your house. If you sold your house immediately, with the value remaining the same, then all you get is your originally 20k, while the rest goes to pay the bank.
Typically, if you make a down payment lower than 20%, your lender will also require you to get mortgage insurance. That means paying a monthly premium that protects the bank from a failure to pay.
How do you build equity?
So you’ve probably figured it out by now: equity is a good thing. You want equity. Not only can it keep you from having to pay mortgage insurance (depending on your loan type), but it’s also nice to have when you decide to sell the house.
Of course, with interest rates as low as they are, and tax breaks offsetting some of the burden, these factors may not be as pressing. Still, if you want want to build equity, there are only a handful of ways to do it.
Make extra payments. You can build equity with just your regular mortgage payments, but it’s going to take much longer than you probably expect. That’s because most banks and lenders front-load the interest into your payment, meaning that for the first few years, most of your money going to the bank, not your equity. If you want to increase your equity, you can make principal payments directly on your loan, no interest added.
Raise your property value. If the value of your home increases, your loan amount doesn’t increase with it. That’s good news for you. Provided you bought in the right area, your property value may rise on its own. However, renovations and improvements can also have a similar effect, so keep that in mind when you decide to put that extra money directly into your equity.