Home ownership is undoubtedly one of the most powerful financial tools a family can have, but while buying your home is an accomplishment on its own, making the most of low interest rates to build equity should be a priority.
Before exploring the best ways to build equity, it’s important to understand exactly what “Home Equity” is, and how it can be used. The equity in your home is the difference between the value, and debts (mortgages and lines of credit) secured against the property. If your home is worth $500,000 and you have a mortgage of $400,000, your equity would be $100,000. The equity in your home doesn’t just boost your net worth, it is also accessible via a refinance, home equity line of credit (HELOC), or a second mortgage. Accessing equity through one of the methods above is a great way to provide for a down payment on a rental property or other investment and is the go-to method for anyone looking to build a large real-estate portfolio.
So, how do we build this equity?
Making More Efficient Payments
This is “the move” to make if you’re looking for an easy way to increase your equity, though it’s important to understand why. Paying bi-weekly or weekly instead of your regular monthly payments does not significantly impact your equity, paying accelerated/rapid bi-weekly/weekly is what you’re looking for. The difference here is that “accelerated or rapid” payments mean you are paying ½ of your monthly payment, 26 times a year, or 52 times in the case of weekly payments (the equivalent of 13 full monthly payments a year), whereas regular bi-weekly payments have the same total paid annually, just in more installments. With the accelerated payments, this extra full payment goes direct to the principal of the mortgage and adds up to 5 full payments worth of equity in a 5-year term, and 60 full payments of additional equity over a standard 30-year mortgage! It is worth noting that paying regular bi-weekly payments does impact the interest paid over the year slightly, but the real benefit is seen when you begin paying more than the minimum.
Increasing Your Payments
Making more frequent payments is a great way for most people to build equity without really noticing, but if you are paid monthly, or self employed, it is not always the answer. If you’re looking to put money straight towards your mortgage but paying more frequently doesn’t line up with when you are paid (or is just too much to stay on top of), using your pre-payment privileges to increase your monthly payments is also an option. We always recommend a mortgage with flexibility, and one where you can increase your payments to have the same impact as paying accelerated bi-weekly, or better!
Making Lump Sum Payments
Another option that’s popular with clients who are self employed, receive bonuses from work, or have seasonal/fluctuating income is making lump sum payments. If you can always make your minimum payments, but have some months that are significantly better than others, keeping your regular payments low and making periodic “lump sum” payments could be the way to go. Like the accelerated payments, these lump sums go directly against the principal owing on your mortgage. It’s also worth noting that with almost all products we offer, you can opt to make both accelerated and lump sum payments! Now that we’ve covered the strategies we recommend, it would be good to touch on the common advice that just doesn’t add up in practice. The next two are the “standard” answers, they undoubtedly will result in more equity, that’s not in question. They simply aren’t the best options, and in most cases just aren’t an option.
Increasing Your Down Payment
The simplest answer is to make a larger down payment, resulting in a smaller mortgage, and more equity. This is a great way to have a mortgage free home sooner or to lower your minimum payments, provided you have the additional funds available. Of course, this is not always an option, and having more than enough money is not a common “problem” we see with buyers, regardless of if it’s their first home, or just another added to their portfolio. Not only is this not always an option, but if your end goal is to use the equity, then putting the money towards your home just to pull it out later would be counter-productive! The goal of this blog is to boost your net-worth, not just switch existing assets from one form to another.
Reducing Your Amortization
Taking a mortgage with a shorter amortization is almost always the idea our clients come to us with, and yes, it absolutely builds equity faster. Where this falls short, is while it increases the amount going to principal (also covered in the previous strategies), it also increases your minimum payment. This minimum payment is what we use to qualify you for a loan, and unlike the recommended strategies, this will decrease your maximum mortgage amount. Going with a longer amortization, but paying more efficiently offers all the benefit of a shorter amortization, without hurting your qualifications, and gives you a lower payment to fall back on if needed.
Whether you’re looking to have equity to access in the future, or want to be mortgage-free as soon as possible, we’re here to help! If you’re in the market for a new home and want to start off right, want to make sure you’re making the most of your existing mortgage, or want to create a long term plan, you can get started by contacting us at admin@ahamortgages.ca or completing a contact form here.
