What is so good about equity?

Here's how it works. Let's say you want to buy an investment property with a market value of $400,000. There are also additional purchase costs (legal fees, stamp duty and so on) of $20,000, bringing the total cost to $420,000.

Assuming that you meet the loan approval requirements, a lender will fund 80% of the property’s market value - potentially more if you're prepared to pay Lenders Mortgage Insurance (LMI). That is, the bank will lend you $320,000 to buy the investment property. As the total cost of the property is $420,000 you still need an additional $100,000 for the deposit and other upfront expenses. This can come from the equity in your existing home.

Let's say the market value of your existing home is $500,000 and the balance of your mortgage is $300,000. The difference between the two is $200,000, which is your home equity.

As an investor you can access up to 80% of your home equity (without the need to take out LMI), which equates to $160,000 in this example. Instead of coming up with a cash deposit for the additional $100,000 needed to buy the investment property, you can take this from the $160,000 of accessible equity in your existing home.

The available equity in your home is calculated at 80% of your home (without the need to take out LMI) less any current loans, which equates to $400,000 less $300,000 = $100,000.

Alternatively some lenders will lend up to 95% of the property value less the existing mortgage, where LMI would be paid on the amount borrowed over 80%.

Building assets in the form of home equity can help increase your net worth. There are several ways you can build home equity, including paying down your mortgage and increasing the value of your home.

Increase Your Down Payment

Increasing your down payment helps build equity because you’re starting off your homeownership journey by having more money in your home. You’ll owe less on your mortgage at the start.

Plus, putting down a larger down payment for conventional mortgages can help eliminate private mortgage insurance (PMI). You’ll need to put down at least 20% down, and could save you from having to pay PMI. If you’re taking out government-backed mortgages like FHA loans, you’ll need to pay mortgage insurance no matter your down payment amount, but you can still build your home equity more quickly by increasing your down payment.

Make Larger Mortgage Payments

Making larger mortgage payments or biweekly payments helps build equity because you’re putting more toward your loan principal faster. That means the faster you pay down your mortgage, the sooner you’ll own more of your home outright. If you have a different type of loan (such as a non-amortizing loan) you may need to make extra payments to increase home equity.

To help you pay down your mortgage faster, you can consider adjusting your budget so you can make larger payments. Look through your spending to see if there are any areas you can cut back or eliminate altogether and use that amount toward your mortgage.

You can also consider increasing your income and using the extra cash to pay down your mortgage. Consider tactics such as working overtime, asking for a raise at your next annual review, or starting a side business.

Refinance Your Mortgage

It may make sense to refinance your mortgage to help you build home equity. Although the amount you’ll owe on the new loan won’t decrease, you may be able to own more of your home in several ways.

One, even if you refinance to the same mortgage term, your monthly payments may be lowered, especially if you refinance to a lower interest rate. You can then take the amount you’ve saved and put it towards extra payments.

The other way that refinancing can help you pay down your mortgage sooner is if you shorten your loan term. Even if you don’t make extra payments, you can still pay down your home loan sooner because of the shorter term.

Keep in mind that if you shorten your loan term, your monthly payments will increase. Be sure to review your budget to make sure you can afford to take on the new loan payments. When you shorten your term, you’re committed to the new, higher monthly payments, and being behind could pose huge risks, especially if your loan goes into default.

Remodel Or Renovate Your Home

When your home value increases, so will your home equity because the percentage of the amount you own goes down. In some cases, you don’t have to do anything — if the housing market is strong and home values increase in your area overall, then it’s most likely yours will too.

However, you may be able to increase the chances of increasing your home’s value by remodeling or renovating your home, and therefore the amount of equity in your home. Not all home renovations increase your home value — it’s a smart idea to speak with an experienced real estate agent in your area to see what can help.

In many cases, adding curb appeal, remodeling your kitchen and main bathroom can increase the chances your home’s market value will go up.

Stay In Your Home Longer

Typically, the longer you stay in your home, the more home equity you can amass, though that’s dependent on how much money you put toward the mortgage principal. Plus, staying longer in the home increases the chance your property increases in value automatically, especially if you live in what’s considered a booming area, or you’ve made a series of renovations over time that increase your home’s value.

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