by Dian Hymer
Equity is the part of your property that's truly yours. It's the current value of a property less the amount of the liens secured against it. Let's say that you own a property that is worth $250,000. You have a first mortgage with a remaining loan balance of $100,000 and a second mortgage with a $50,000 balance. Your equity in the property is $100,000.
Repeat home buyers usually rely to some extent on the equity in their current home to help buy their next home. The more equity you have, the larger the possible down payment for the trade-up home.
You probably won't receive the entire amount of your equity as cash when you sell your home. Most sellers use part of their equity to pay selling costs, such as brokerage commissions and transfer taxes. Also, if you are delinquent on your property taxes, or have other liens secured against the property, such as an IRS tax lien, these would have to be paid at closing.
In past years, homeowners saw their equity grow significantly due to home price appreciation. Appreciation is the increase in the value of a property. Picture this: You bought your first home for $125,000 in 1985 with a 10 percent down payment of $12,500, and a mortgage for $112,500. By 1989, your property had doubled in value to $250,000. After you paid back the mortgage and your selling costs, you were left with about $122,000 in cash.
Some of this cash might have been used to pay the closing costs on the new home (points, title insurance, etc.). Still, you would have had about $110,000 for a cash down payment. Depending on what size loan you qualified for, this cash would have facilitated the purchase of a much more expensive trade-up home. For example, a mortgage for 80 percent of the purchase price combined with a $110,000 cash down enables the purchase of a $550,000 home.
In recent years, many real estate markets around the country have experienced depreciation--the loss of property value. Some first-time buyers, who purchased with a 10 percent down, lost their equity, and more. Today many of these markets have turned around; some are in the process of doing so. However, economic experts predict that future home price appreciation will be moderate--significantly less than the appreciation rates of the late 1980's.
First Time Tip: There are ways to increase your equity that don't depend on appreciation. One is to make extra principal payments to decrease the amount of your mortgage. This not only increases your equity, it also decreases the ultimate amount of interest you will pay to your lender.
Some mortgages build equity faster than others. For example, a loan which is paid off over a 15-year time period will allow you to build equity faster than will one that is paid off in 30 years. But, the monthly payments are higher on a 15-year loan. This makes qualifying for a loan more difficult.
Another mortgage option is a 30-year mortgage with a bi-weekly payment plan. These loans enable you to build equity faster than you would with a conventional 30-year mortgage. However, not all lenders offer this payment option.
With a bi-weekly mortgage, the borrower makes a payment once every two weeks rather than once a month. A 30-year loan with a bi-weekly payment plan is paid off in about 20 years.
The Closing: Another way to build equity is to make improvements that add value. This can also make your home more enjoyable--except while construction is in progress.
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