If you own a home, “home equity” is a major perk of homeownership but a term that you may not fully understand. If you are in the process of purchasing a new construction home, knowing how much equity you have and how you can best use it to your benefit will be extremely beneficial. Let’s explore more about this topic below.
How Home Equity Works
Unlike a rental home, buying a new construction home (or an existing home) means you can actually get money back in the future. The reason is home equity. Defined, it means the current value of your home minus what you owe. Unless you pay for your home 100% in cash, you likely will use a mortgage loan to cover part of the cost. That means you will own a portion and your lender will hold the rest. As you make payments on the mortgage, your share grows and your lender will gradually own less and less. If your home were a pie, your piece of pie would get bigger as your lender’s slice gets smaller.
You can use either a number or a percentage to represent home equity. Someone who buys a home straight up owns the entire home, meaning they have 100% equity. If this same home had a market value of $500,000, they would similarly have $500,000 in equity.
How Home Equity Is Calculated
Granted, most people don’t purchase their home outright. Let’s say you buy that $500,000 home with a 20% down payment and finance the remaining $400,000 with a home loan. To calculate your home equity, subtract the loan balance from the home’s value.
Current home value – current loan balance = Your home equity
As soon as you close on your new construction home, you have $100,000 equity, a number which gradually increases as you pay down the mortgage. To determine home equity as a percentage, just divide the home equity number by your home’s current market value.
Your home equity ÷ current home value = Percentage of equity
So if you have $100,000 in equity and your home has a current market value of $500,000, you have a 20% slice of equity while your lender owns the other 80% of the pie.
How Home Equity Changes
Home equity does change over time. It increases as you make monthly payments and pay back the principal owed on the mortgage. Market conditions may also have a dramatic effect on the value of your home equity. Using the example of our $500,000 home, let’s say you have paid $50,000 of the principal by making monthly payments, along with your initial $100,000 down payment. That leaves $350,000 that you still need to pay.
Due to increasing property values in your area, you compare your home to similar houses and discover its market value has likely risen (though you will need to request an appraisal to be certain). You conclude that your home’s current worth is about $575,000. Here is how to estimate your new equity:
$575,000 current home value – $350,000 still owed = $225,000 in home equity
$225,000 in home equity ÷ $575,000 current home value = 39% home equity
Since the home has increased in value, your stake is now worth $225,000 instead of $150,000. You also have a greater percentage of equity — 39% instead of the 30% you would have had if the value had not changed. This appreciation makes it easy to increase your net worth without any extra effort.
However, the opposite can also happen. Let’s say you buy a $500,000 home, pay off $150,000 and still owe $350,000 on the mortgage. If the value of the home has decreased $20,000 since you bought it, your home equity will be a smaller percentage of the pie. Here are the new calculations:
$480,000 current home value – $350,000 still owed = $130,000 home equity
$130,000 home equity ÷ $480,000 current home value = 27% home equity
Despite paying $150,000 toward the loan balance, in the current market, your share is worth $20,000 less than you paid for the home. Your percentage of equity has also decreased, meaning you own 27% of the home rather than the 30% you would own had the price remained stable. The good news is that even if your home value drops, it can always rise again. This makes it important to time the sale of your home so your share of equity is as valuable as possible.
Want to Build Your Home Equity?
There are several ways to boost the amount of equity you have in your home. Here are some of the most effective:
- Make a larger down payment. When you purchase a home, the more you put down, the more you’ll own at closing.
- Pay the mortgage consistently. By making consistent, on-time payments, you increase equity faster and own a bigger share of the home.
- Refinance to a shorter-term loan. If you have wiggle room in the budget, consider fast-forwarding the payoff process by refinancing to a shorter-term loan. You may even get a better interest rate.
- Make high-value improvements. If you plan to sell in the near future, research which renovation options will most effectively increase the value of your home.
- Stay put. Real estate experts recommend staying in a house for at least five years to recoup costs and make a profit from the sale thanks to increased property value.
Build Your Dream Home With Gateway
Investing in a well-built home in a neighborhood with property values that are projected to increase is one of the smartest methods to build wealth. At Gateway Construction, LLC, we take pride in building high-quality new construction homes that cater to our clients and their wants and needs. We can help you design and build a custom home, or you can choose from our portfolio of customizable floor plans. To get started, call our team at (307) 632-8950 or contact us online to speak to a member of our sales team.