One of the biggest advantages of home ownership is that it provides an investment that instantly begins to build equity. Equity is the value built as home prices rise, or as you pay down your mortgage.
What makes home ownership lucrative is that you don’t necessarily have to see home prices rise to build equity in your home. With every mortgage payment you make, equity rises, and your liability is reduced. While just living in your home and paying down your mortgage will build equity, there are other ways you can help raise the value of your equity even more.
HOW LONG DOES IT TAKE TO BUILD EQUITY IN YOUR HOME?
Although you have instant equity in your home based on the money you paid towards your down payment, you will slowly begin to build more equity with each mortgage payment. Keep in mind that for the first several years you are paying towards interest and principal. The principal is the actual balance of your mortgage. Over a period, that averages about five to seven years, you will be paying more towards interest than principal. However, after this period equity builds more quickly as you are paying strictly towards the principal.
There is also home value to be considered. For example in the 416 area of Toronto, prices for detached homes rose a whopping 19.5 percent from December 2018 to December 2019, while semis rose 7 percent and condos rose 10.3 percent. That is quite a bit of equity. On the other hand, townhouses saw a very modest increase of just 0.4 percent.
HOME EQUITY 101
Home equity may sound like a complicated investment term, but it’s actually quite simple. To understand how much equity you have in your home, you look at the current value of your home and deduct how much you currently owe on your mortgage. The difference represents your equity.
If you paid $500,000 for your home, and made a 20 percent down payment, your balance at the time you purchase your home is $400,000. Right from the start, you have $100,000 of equity in your home. For arguments sake, if you decided to sell your home right away, and you sell it for $550,000 the bank gets the $400,000 you owe them and you get the $100,000 you paid up front for your down payment, plus the $50,000 gained due to the increased value of your home.
As your home value increases, and your mortgage balance shrinks, your equity continues to grow. If you were to sell your home in five years for $650,000, your equity has grown quite a bit more, while your mortgage balance has continued to shrink. If you had a five-year fixed mortgage at 3.14 percent interest and an amortization period of 25 years, your payments would be $1,922 per month. That means your balance would be $342,813 at the time you sell. Your equity, in other words the money you receive from the sale, would be $307,187.
SMART MORTGAGE CHOICES HELP BUILD HOME EQUITY
As you can see, building home equity can pay off in just a few short years. You can help boost home equity by making smart mortgage choices including:
Make the biggest down payment you can afford to increase your home equity from the start. As mentioned above, if you make a 20 percent down payment, you already have 20 percent equity of the sale price, whereas if you just made a 5 percent down payment and sold right away you would only get $25,000. Keep in mind there are rules about how much down payment is required based on the price of your home:
$500,000 or less: 5% of the purchase price
$500,000 to $999,999: 5% of the first $500,000 of the purchase price and 10% for the portion of the purchase price above $500,000
$1 million or more: 20% of the purchase price
Pay Down Your Mortgage
This is a given, but there are some considerations around paying down your mortgage. Discuss what options are available to help you pay down your mortgage faster with your lender. For example, you can make bi-monthly payments instead of monthly payments. As well some mortgages will allow you to make a lump sum payment towards your mortgage if you come into a wind fall, or increase your monthly payments without a penalty, while some won’t. You can also discuss a shorter term with your lender which will help you pay off your mortgage more quickly.
DO RENOVATIONS HELP BUILD EQUITY IN YOUR HOME?
Investing in renovations can help increase the value of your home, which in turn increases your equity. Because you have to deduct what you spend on your renovations from your increased home value, you want to ensure you get the best possible ROI on your renovations. According to the Appraisal Institute of Canada (AIC) these are the most ROI-driven home upgrades you should invest in your home to help build equity:
Kitchen: You are often better off focusing on upgrades such as new counters, stainless steel appliances, and aesthetic changes instead of an entire kitchen renovation. A kitchen makeover can have an ROI of as much as 75 to 100 percent.
Bathrooms: As with kitchens a complete renovation is not necessary to see a great return. Consider upgrades like new tiles, attractive faucets and vanities, and high quality spa shower heads.
Flooring: Although your ROI is not as high as for the kitchens and bathrooms you will get on average 50 to 75 percent back. One of the benefits of hardwood or even laminate is that it instantly raises the value of your home in the buyers’ eyes.
Energy upgrades: Energy-efficient windows, HVAC systems, and energy upgrades such as a new roof or even solar panels are top of mind for today’s home buyers as these upgrades help reduce energy bills. This can bring a return of 50 to 75 percent.
A common renovation mistake that can negatively impact your equity is to over invest in renovations. When this happens, you can greatly reduce home equity due to housing prices in your area. Consider speaking to a real estate agent to get an idea of what homes are selling for in your neighbourhood before you begin renovations and invest accordingly.
Building home equity not only helps you see better profits when you sell your home, but also provides access to home equity loans to invest in things such as renovations. It provides a nest egg when you retire allowing you to look at HELOCs to access your equity without having to sell your home. It is certainly worth investing in a home when equity is so easy to acquire.
If you are considering buying a home, speak to the real estate experts at Onlywith.ca. We can help you find a home in your chosen area so that you can get started with building your home equity.