Definition
Equity buildup is the gradual increase in a mortgagor’s equity in a property over time, primarily driven by the amortization of the loan principal. This means as the homeowner makes regular mortgage payments, a portion of each payment reduces the loan balance, thereby increasing the homeowner’s stake in the property.
Examples
Example 1:
Echols purchased a home for $300,000, with a $50,000 cash payment and a $250,000 mortgage loan. After five years of regular mortgage payments, the principal of the loan has reduced to $210,000. Assuming the home’s market value remains at least $300,000, Echols’ equity in the property has increased by $40,000, reflecting the reduction in mortgage principal.
Example 2:
Mariana bought an investment property for $400,000, using a $320,000 mortgage. After seven years, she managed to reduce the mortgage principal to $280,000 through regular payments. Irrespective of market fluctuations, her equity buildup through amortization contributed an additional $40,000 to her equity.
Frequently Asked Questions (FAQs)
What causes equity buildup?
Equity buildup is primarily caused by amortization – the process of paying down the principal balance of a mortgage over time. Additionally, it can be influenced by property value appreciation.
How is equity different from down payment?
A down payment is an upfront payment made to secure a property purchase, contributing to initial equity. Equity, over time, increases with principal repayment and property value appreciation.
Can equity buildup be used for other financial purposes?
Yes, accumulated equity can be accessed through home equity loans, lines of credit, or refinancing. This capital can fund renovations, educational expenses, or other significant financial needs.
Does property appreciation affect equity buildup?
While equity buildup mainly refers to principal reduction, property value appreciation also contributes to overall equity, enhancing the owner’s net worth.
What is amortization?
Amortization is the reduction of loan principal over time through scheduled payments. Each mortgage payment covers interest due and a portion of the loan principal.
Related Terms with Definitions
Mortgage
A loan used to purchase or maintain real estate, collateralized by the property itself. The borrower makes scheduled payments over time.
Principal
The initial size of the mortgage, or the outstanding balance excluding interest. Principal reduction is a key factor in equity buildup.
Amortization
A payment plan that gradually reduces the loan balance over the term through scheduled payments of principal and interest.
Refinance
The process of obtaining a new mortgage to replace an existing one, often to take advantage of lower interest rates or access equity.
Home Equity Loan
A loan that allows homeowners to borrow against their property’s equity. It is a second mortgage secured by the property value.
Online Resources
- Investopedia on Home Equity
- Fannie Mae’s Guide to Home Ownership
- Federal Reserve: Equity and Housing
- HUD Home Equity Conversion Mortgages
References
- Investopedia. “Home Equity.” Investopedia, 2023.
- Federal Reserve. “Supervision and Regulation Letters.” Accessed October 1, 2023.
- “Hidden Wealth: The Economics of Real Estate,” by N. Gregory Mankiw. 2020.
Suggested Books for Further Studies
- “Real Estate Finance and Investments” by William B. Brueggeman and Jeffrey D. Fisher
- “The Book on Rental Property Investing” by Brandon Turner
- “Rich Dad, Poor Dad” by Robert T. Kiyosaki
- “Investing in Real Estate” by Gary W. Eldred
- “Equity Management: The Art & Science of Modern Quantitative Investing” by Bruce I. Jacobs and Kenneth N. Levy
