What is Equity and How Can I Build Mine?
Owing a Little Less and Owning a Little More
Even if you are buying a Makati condo or a house and lot, one of your priorities should be building equity. Perhaps, you have heard the word equity many times before, but didn’t truly understand what it means and how it can be advantageous for you. This article will discuss what equity is, how to build it and what you can do with it. Put simply, after reading this, you will understand why building home equity could mean owing a little less and owning a little more.
What is home equity
Home equity refers to what you own in actuality as you pay your mortgage. With each payment you make against the total amount you owed to the bank or developer, your home equity increases. As we all know, your home is not completely yours until you paid the bank in full, for instance. With an increasing home equity, however, you are inching closer to owning your home entirely. Owing less and owning more.
Here is how equity is calculated. Let’s say the current worth of your home is Php 3,000,000 and you still need to pay Php 2,000,000. This means you have already built a home equity of Php 1,000,000. You may further build your home equity by paying off the remaining balance.
How to build home equity
There are several ways to build home equity. In fact, you can build equity early on in the process.
1) Provide higher initial down payment
This is your first opportunity in building higher equity. If you have the extra money to pay for a larger down payment, do so. The down payment is usually 10 to 20% of the total amount. If you can pay for 25% or higher, the better.
2) Make extra principal payments
Again, if you have extra money, then double your monthly mortgage. The practice impacts your equity twice as you’d expect. Every peso you pay means a reduction on your total mortgage loan by the same amount. Reduced mortgage loan amount also means a sizable reduction in the interest that you have to pay for the rest of the mortgage term. In simpler terms, you get to pay more of your principal than of the interest.
3) Get a shorter mortgage term
Shorter home loan term means paying your principal and obtaining equity much quicker. If you are not able to secure a shorter term, you have a choice to refinance. Through refinancing and given your financial capacity, you may pay more monthly. The upside is you need to pay less number of months, so you gain more equity on a monthly basis.
4) Consider home improvements
Improving the quality of your home not only increases its value, but also its equity. However, be cautious of the type of improvement that you consider by making sure that the improvement is geared toward increasing the condo or house’s value appreciably. A whirlpool will not increase the value of your home, but a kitchen remodel will.
Why building home equity is important
While some experts refer to home equity as forced savings, it cannot be compared with having money in the bank. Not quite. However, since it is also an asset, it can be traded with other forms of asset.
Your home equity can be used in obtaining a second loan, which is known as home equity loan. Your home equity is no longer tied up in any other debts. This means that you have already paid for that portion, so you can borrow against your equity. A home equity is very helpful when financing something expensive such as a new car, wedding, college tuition or home improvement.
Some banks may give you only up to 50% of your home equity while others may consider letting you borrow an equal amount of such. The money will be given to you in a lump sum. You need to pay back the monthly repayment of your second loan after a fixed period of receiving it. An interest will be charged right away.
Another type of home equity loan is known as the line of credit. The amount will be also based on the amount of your home equity. However, this will not begin in a lump sum. Instead, you will be issued with a debit card or checkbook, whichever you choose in accessing the money. You only have to pay for the loan after spending the money. Payments and interest will depend on the amount of money you spend, let’s say, within one month.
What else can I do with my home equity
Other than obtaining home equity loans, there are other ways by which your home equity may be beneficial for you. One example is if you want to sell the condo or house. You will obtain cash for your equity after selling the property. If you want to buy another house using the money you obtained as equity, it means purchasing a new house at a lower mortgage amount and shorter mortgage term. You may also pay for a higher down payment. Whichever you choose, just make sure you will not experience a negative equity.
What is negative home equity
A negative equity occurs when you owe more than the worth of your home. Having a negative home equity is typically a result of bad decision-making. For instance, you want to improve your home’s quality, so you borrow against your home’s equity to cover the improvement expenses. In the long run, however, you realized that the series of improvements are not providing your home any value.
To continue with the example above, let’s say your current home equity is Php 1,000,000. You borrow the same amount of equity for your planned improvements. The total improvement cost, however, is Php 1,500,000. That’s a negative home equity of Php 500,000 wherein the liability exceeds the asset.
A negative home equity must be avoided otherwise you will just owe more and own less. Nonetheless, now that you’ve understood what home equity is and how important building equity is, avoiding a negative equity will be much easier. The secret is building your home equity slowly and surely while also grabbing every opportunity of building it further.
Image credit: AlwaysInfo.co.uk