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When you buy a home, it may feel like you will never pay it off or build any equity. During the first years of your loan, only a small portion of your monthly payment actually goes to principal.
With a whole bunch of factors that come into play, the equity in your house can go up or down.
Home equity is the amount of money a homeowner would receive upon the sale of their home after their loan was paid off. That is how David Snyder, financial advisor with Northwestern Mutual in Omaha, defines it.
“Home equity can help homeowners increase their overall net worth,” he adds. “A person’s net worth is a way to keep financial score over the years.”
They can also use this equity for home improvement or even starting up their own business. Later in life, they can even use the equity in their home for retirement income, if needed.
The amount of equity in a home can mean whether or not someone can upsize or build on. It can also decide whether they can move to a more expensive neighborhood or area of the country.
Here are some of the factors which can help or hinder home equity:
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Underwater value
Unfortunately, the value of someone’s home can change for the worse over the years, Snyder says. For instance, during the housing crisis in 2008, many people’s homes became “underwater.”
Suppose you buy a home at a premium price and the housing market declines. You can then find yourself owing more on the home than you can sell it for. You have no equity in it.
If this happens and you try to move, you may owe the bank more than the buyer of your home pays you.
Neighborhood value
Your location can have a lot to do with your house’s future sale price, he adds.
“If you have good school districts, this can affect the price and the tax that you pay on a home,” Snyder explains. “You also have to look at the other homes in the neighborhood. If you are looking at the nicest home in a neighborhood, this could hinder the future sale of your home or the appreciation of your home.”
School value
ATTOM Data Solutions (then the parent company of RealtyTrac) did a study on schools and home values in 2016. It shows that homes in zip codes with at least one good elementary school have higher values. Those homes also have stronger long-term price appreciation than homes in zip codes without any good elementary schools.
The 2016 ATTOM study compared these homes with homes in zip codes without any good schools. On average, homes in zip codes with at least one good elementary school were worth 77 percent more.
Stable value
If you refinance or end up selling a few years after buying, you might not recoup all your closing costs.
“If you take the overall closing costs and divide them by the amount you are saving per month, you will find your break even number,” he says. “It all depends upon the length of time you plan to stay in your home to determine if refinancing is worth it.”
Building equity faster
The faster you build equity, the better for you. You can do this in many ways even if you are just in the beginning years of your mortgage.
If you can make a bigger downpayment in the beginning, your loan will be lower. That means you already are ahead with more equity to start out with.
You can also get a shorter term loan. You will save money on interest payments. Plus, more of your monthly payment will go toward the principal rather than just interest in the beginning.
Estimating your home value and equity
If you want to know the estimated value of your home, there are plenty of online estimators. Some calculators use home valuation data from millions of home records. All you do is enter your address.
Others calculate by the years remaining on your loan and an assumed yearly appreciation rate. Actual appreciation varies.
Example of how much equity a home can build
Say you use an online home equity calculator on a home purchased for $300,000. The buyer makes a $50,000 downpayment and has a four percent interest rate. With principal payments and appreciation, the home may build to $1,296,583 of equity at the end of the 30 year loan. That assumes the home appreciates 5 percent a year. Actual appreciation varies, and slower growth would mean much less equity.
Of course, some circumstances aren’t included in the estimator. For example, a homeowner might take out a home equity loan for college expenses. A homeowner might also have expanded upon the original home.
When buying a first home or a newer/larger home, think of your other financial priorities as well, Snyder said.
“If some of your financial priorities are to take your family on special vacations, pay for college education for your kids or be in a financial situation to retire early. You will have to determine if the extra cost of a larger home is worth it,” Snyder says. “Take all of this into account when you are doing your planning and try to not let emotion get too involved.”
