How to Increase Your Home Equity
August 31, 2021
If you own a home, or you’re planning on buying one, a basic but important financial principal worth understanding is home equity.
By and large, most of us borrow a large share of the cost when purchasing a property. However, buyers also make a down payment, often something in the range of five to 20 percent of the overall price. Once the sale is complete, the new homeowners immediately begin paying back their financial institution or lender with regular mortgage payments.
Over time, a couple of things happen. First, those payments slowly eat into the loan principal, reducing the amount owing (and, importantly, the amount of each payment that goes toward interest). Second, the market value of the home changes based on a range of different factors impacting the local housing market.
What is home equity, and how do you calculate it?
Simply put, home equity is a dollar amount that represents the value of a homeowner’s stake in his or her home. It’s calculated by taking the current market value of the property and subtracting whatever amount is still owing on the mortgage, or to any lenders.
While an increase in value is never guaranteed, property prices have typically displayed consistent growth across much of Canada in recent decades. As a result, most homeowners see their home equity increase as they pay down their mortgage and ride a rising tide of property prices.
For example, say you bought a house four years ago for $500,000. You made a $50,000 down payment at the time and, in the years since, you’ve put $40,000 in payments towards the mortgage principal, leaving $410,000 still owing.
Meanwhile, thanks to soaring home prices in your area, your property is now valued at $600,000. Thus, your home equity calculation is $600,000 - $410,000 = $190,000.
What is home equity good for?
Home equity is like a secret bank account you can use in case you need access to cash, perhaps for a renovation project or to pay for a child’s post-secondary education. Once you’ve built equity in your home, you can borrow against it, either as a home equity loan or a home equity line of credit. It’s why some people think of their mortgage payments as a forced savings plan.
Additionally, building home equity helps ensure you’ll come out ahead when you eventually sell your property, because the sale price is more likely to be greater than the amount still owing on the mortgage.
How to build equity in your home
Depending on your situation, there are a few different things buyers and homeowners can do to increase the value of their home equity.
Increase your down payment or make a lump sum payment
If you’re preparing for a home purchase and can increase the size of your down payment, the extra savings you part with in the short term will immediately become home equity that can be borrowed against if necessary.
If you already own your home, you may be able to make an annual, penalty-free, lump sum payment toward the principal, typically up to a certain percentage or amount of the remaining balance.
Increase your mortgage payment amount, or accelerate your repayment
Some financial institutions allow their clients to overpay on their regular mortgage payments, directing the additional amount to paying down the loan principal. If you can afford this, and your borrower allows it without penalty, it’s an effective way to build the value of your home equity by reducing the amount still owing on the mortgage.
Alternatively, consider refinancing your mortgage and reducing the length of the repayment term in exchange for more favourable interest rates. Shortening the term will increase the size of each regular payment but, if you can afford the switch, the benefits of even a half point reduction in your interest rate can soon lead to hundreds, if not thousands of dollars in savings.
Increase the value of your home
Finally, a home renovation project that increases the market value of your home will, in turn, give you greater home equity. Whether it’s a new kitchen or bathroom, finishing a basement, building an addition, or adding a backyard pool, there are countless ways to make your home more marketable, thereby boosting the value of your equity stake.
If you want to renovate but don’t have cash on hand, you can finance a project by borrowing against your home equity, making use of your ownership stake while simultaneously increasing its value.