Keys and deed in hand, owners of a new home now settle in. The financial scrutiny is over, paperwork signed, move navigated. Now it’s time to start repaying the multi-year obligation buyers signed up for with so much anticipation.

In other words, new homeowners begin building equity in their dwellings.

What Is Equity?

Home equity is the difference between a property’s fair market value and the outstanding balance of the mortgage.

An example: Consider a $500,000 price tag on a home that results in a $450,000 mortgage (asking price minus down payment). That $450,000 over a standard 30-year mortgage translates to 360 payments of $1,250 (absent taxes and fees, eliminated from this example for simplicity’s sake).

Month one of ownership, when the resident remits that first $1,250 payment, he or she immediately owns 1/360th more of the property than before.

That simple transfer of funds has increased the owner’s equity — the property’s value to the resident — by one installment.

Over the course of making those 360 payments, that stake continues to grow, payment by payment.

It’s a long game, but one with numerous advantages for the owner — ones that go beyond just the elimination of the debt when fully paid.

Increasing Homeowners’ Stakes in Their Residences

In addition to making the contracted mortgage payments, there are other ways to build equity after taking ownership of a house:

• Increase the amount of the mortgage payment. Or the frequency. Or both. A bump of what may seem like a nominal amount can make a big difference when paid month-by-month, year-by-year.
• Refinance. If residential real estate mortgage rates drop, it may be worthwhile to call a total reset on the loan, relaunch the transaction with new terms (the lower rate), and continue to chip away, this time paying less. Be aware, however, that the associated fees regarding mortgage applications and processing will require payment during this second go-around. Or any subsequent refinance transactions. Factor those expenses into the overall analysis on whether to refinance or not.
• Tap Additional Sources of Income. This strategy can be as simple as trimming a monthly budget or finding a second job. In either case, the resulting financial resources applied to the continual reduction of mortgage debt can be very advantageous.
• Invest in the Home. Home renovations — adding a swimming pool, installing a tankless water heater, converting an unfinished basement to a swanky office — are sure ways to increase a property’s value. They also, however, require resources (payment for materials, permits, contractors, etc.) that can lessen the upsides. Careful consideration is a good idea.

Also know that rises in home values can be organic, requiring nothing more from homeowners than patience.

In the market increase of general homeowner values, all boats rise in the tide. Through no effort but fortunate circumstances homes can increase in worth. But that windfall may be short-lived. As prices rise almost inexplicably, they can drop with similar suddenness.

What to Do with Equity

Building equity has a long payoff. A 30-year mortgage can seem like an eternity, especially if emergency needs for a household’s finite income arise.

Fortunately, financial products exist to enable homeowners to “borrow back” some of the cash they’ve paid for their four walls and roof.

The two most common vehicles for doing so are:

• Home equity loans, which tie to bank accounts, making repayment an easy process (that can have tax and interest-rate advantages)
• Home equity lines of credit, which offer the flexibility of being available when needed. Their interest rate is tied to prime, the loan rate that commercial banks charge their most creditworthy customers

These products are available at most financial institutions, including Penn Community Bank.

For more information on equity, the strategies to build it, and the uses for it, contact Penn Community Bank.