Equity: What is it? Why do I want it? How can I build it quicker?
We have been receiving a lot of finance questions from our clients about purchasing a home. We want to make sure our clients receive the most accurate information, so we teamed up with Karen Jackson from First Priority Mortgage to answer the most common real estate finance questions. Karen has been providing lending advice and assistance for over 20 years in PA, DE, and NJ. She is one of our in-house mortgage lenders at Keller Williams Brandywine Valley that we recommend to many of our clients.
Now, lets talk about equity. What is it, why do I want it, and how can I build it quicker?
What is equity?
Equity is the difference between what you owe on your mortgage and what your house is worth.
Equity is kind of like a savings account. Each month, part of your mortgage payment pays down your principal balance, while the rest pays off the interest. By paying down the principal balance, you are building your equity. When you sell your house, you will get to take that equity and put it into purchasing your next home, or keep the money and put it into your savings.
When you purchase a property, you can start off with some equity if there is a difference between the price of the property and your mortgage amount. So if you pay more upfront, and take out a smaller mortgage, you’re starting off with some equity.
Why do I want to build equity?
Building equity can be beneficial in a couple ways. Even if you are not planning on staying in your house for very long, by building equity, you will have more money to put towards your next house. You can build equity faster by paying extra towards your principal, which could allow you to buy a more expensive house, or put down a larger down payment so that your monthly payments can be lower. Either way, when you move, you take your equity with you and can continue to build it over a lifetime.
You can also use your equity along the way, if you need to. Some people tap into it by getting a home equity loan to pay for college expenses or home improvements. Others will just let their equity build up until they retire, and then will downsize. Once their house is sold, they can decide to take their equity and put it into their savings to help them live a more comfortable life now that they are done working.
How can I build my equity quicker?
Mortgages, like most loans, have you paying more interest at the beginning and less interest near the end. So, you are paying less principal at the beginning, and more principal at the end.
A trick to reducing your payment schedule is to pay extra towards your principal balance. You will not only gain the equity of the extra amount you are paying towards principal, but you will also pay off your loan quicker. A good rule of thumb is that one extra payment per year towards your principal balance will reduce your total mortgage term by almost 8 years. So instead of paying your mortgage off in 30 years, you will be able to do it in closer to 22 years. That's huge savings!
As Realtors, we cannot give advice on mortgages, so make sure you talk to a mortgage professional to learn more about your individual situation. If you would like us to put you in touch with a mortgage lender, we can give you a recommendation.
If you are thinking about starting the home buying process, we would love to help! Send us a message, or check out our FREE How To Purchase A Home Guide, and let us answer any questions you may have. Make sure you keep an eye our for our next real estate finance blog post which will be about choosing what type of loan you should get.
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If you missed our last finance post about deciding if you should rent or buy, you can check it out HERE.