Welcome to my new blog series, Home Buying 101! I will be detailing the various parts of the transaction process for purchasing a single family home. My goal is to answer the many questions looming around purchasing, especially for first-time home buyers.
There are a lot of words thrown around when discussing purchasing property. One of the most confusing concepts for first-time home buyers is equity. It’s not a dirty word, I swear.
Equity in real estate is defined as the difference between the market value of your property and what you owe to the lender for the mortgage. For example, let’s say the market value of your home is $150,000 and you owe the lender $120,000; that makes your equity $30,0000. Sometimes equity is expressed as a percentage, in this case it would be 20% equity.
There are several ways you can build home equity:
- Down Payment: Which is the initial investment monies put into your home to reduce the mortgage payment. Using the example from above, a down payment of 20% (to avoid PMI) on a $150,000 home is $30,000. The lending amount is the price of the home minus the down payment, which is $120,000.
- Mortgage Payments: As you make regularly scheduled payments to your mortgage, the amount owed to the lender decreases. Assuming the market value of your home stays the same, the difference between it and the lending amount will grow larger, thereby increasing your home equity.
- Extra payment on Mortgage Principal: Similar to making regularly scheduled payments, if you pay additional monies towards the loan principal, the loan amount goes down which increases the amount of equity.
- Home Improvements: Renovations or upgrading finishes to your home increases the market value of your home! An example would be if you removed the carpet in your home and installed laminate flooring instead. By doing so, the value of your home has increased, which raises the difference between it and what you owe the lender, which increases your home equity.
- Market Value Appreciation: When similar houses around yours sell for a higher price, that raises the value of your home. Again, raising the market value of your home increases the difference between it and your loan amount which in turn raises your home equity.
Conversely, there are ways that home equity can decrease:
- Principal Loan Amounts Increase: Some ways that the principal loan amount increases are if you refinance your mortgage, take out a second mortgage or home equity loan. Because you would be narrowing the difference between the loan amount and the market value of your home, it would be reducing the amount of equity.
- Market Value Depreciates: Opposite to the example above, if similar homes around your house is selling for a lower price, then your equity has decreased. Let’s use the example from above – you bought your house for $150,000 with a 20% down payment (equity) of $30,000. Now similar houses to yours in your neighborhood are selling for $115,000. You no longer have equity in your home because your equity has dropped by $35,000. If you sold your house at this new market value of $115,000 while owing $120,000, you would have to pay the lender $5,000 to make up the difference.
- Home Destroyed by Disaster: Heaven forbid your home encounters a disaster – a fire, hail storm, tornado, or flooding. If you don’t have enough insurance money to pay for the repairs, you will probably need to get another loan. This would add to your existing principal loan amount, further decreasing the difference between it and the market value of your home, which lowers your home equity.
- Maintenance Delayed: Keeping your home well-maintained is important to be sure things do not stop working appropriately. If you don’t take care of the needed repairs, the cost to fix them will grow larger and take away from the equity in your home.
Why is equity important? Take a look at Part Two: Renting vs. Buying!
Katie Langthorn | Real Estate Agent, REALTOR®
C: 281.850.7743 | O: 979.703.1979 | F: 979.703.1980
1580 Copperfield Pkwy, | College Station, TX 77845
Your Source for Bryan/College Station Real Estate