First timers are often left dazed and confused by the barrage of new terms they encounter as they embark upon the process of buying a home. Beyond securing a down payment, locking in an interest rate and choosing a mortgage, they may become confused with discussions that bring up words like amortization, equity, principal, and so on.
For starters, amortization is the actual act of paying off a loan in set installments over a fixed amount of time. The principal balance of a home loan reflects the original amount borrowed. As you pay your mortgage each month, you are building equity and increasing your net worth. Equity is the value of the property that you own or what you have paid off each month. A home’s equity is also combined with the amount of appreciation, or amount that your home has increased in value over time.
Now, to ramp up the level of confusion a bit more, there are two types of equity, cash equity and market equity. Here’s a look at each:
This reflects the amount of money the homebuyer has directly invested towards the purchase of the property. Anyone who does not buy a home outright, typically begins the venture by placing a down payment on the purchase. The down payment is usually 20 percent of the agreed upon selling price. A home under contract for $150,000 would require a down payment of $30,000.
A homeowner’s cash equity status does not fluctuate as long as loan payments are made on time. Cash equity builds up each month as part of the house payment is applied towards the principal, or the amount of cash that was borrowed.
In terms of single-family homes, a property’s market value is calculated by evaluating real estate statistics, including price comparison figures, DOM-days on market, or how long similar properties are taking to sell, the level of demand, and appreciation rates. Here is an excellent example of market equity illustrated from Investopedia’s site: “If someone bought a $100,000 house with 20% down and the house was now worth $130,000, that owner would have $20,000 in cash equity in the property and $30,000 in market equity.
Most hopeful home buyers don’t consider the prospect of market equity when they set out to become property owners. Many just want to find the perfect house in a great neighborhood. Of course, real estate speculators have been playing the market equity game by taking calculated guesses based on predictions on rising prices, appreciation, and demand as long as folks have been buying and selling homes.
So, what factors can cause a home to appreciate?
- Do you live in an area where higher paying jobs are being created? People move into communities when job opportunities are available which pushes up the demand for real estate and can result in rising home prices and a higher than usual rate of property appreciation.
- Beach homes, lakefront properties, mountain, desert and other resort communities are seeing tremendous rates of appreciation. Turns out all those retirement age Baby Boomers want housing options with built-in recreation like watersports, hiking, biking, and skiing.
- College towns also maintain an ongoing demand due to the constant ebb and flow new students, grads and instructors.
- Areas that boast low property taxes may also experience bursts of new residents, which increases the demand for housing and boosts appreciation.
- Major changes to the local infrastructure such as the opening of a new interstate highway, mass transit system or change in traffic patterns can dramatically impact the demand for real estate.
- Notable increases in population, which can be easily obtained online through the U.S. Census Bureau, are more indicators that the local housing market could see heightened activity and rising appreciation.
- Housing starts, which are tracked by Trulia and Zillow, also reflect demand in certain areas and signal increases in home prices.
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