Almost all banks or financial institutions appoint an appraiser to calculate home equity. The appraiser considers many factors before arriving at the fair market value of the property
HOME equity, in its simplest form, is the current market value of your home minus the loan outstanding. This is the portion of home value that you own. If the current value of your home is Rs 50 lakh in the market and the mortgage loan outstanding is Rs 30 lakh, the home equity will be Rs 20 lakh (Rs 50-30 lakh). Home equity helps you when you plan to take a loan.
Factors influencing home equity
Home equity is possibly the biggest asset that a family owns. Hence, it is important to know what factors affect your home equity.
Change in price of property
The real estate market directly depends on growth rate of the economy, demand and supply and prevailing interest rates. During good times, real estate is one of the best investments, while during adverse phases of the economy, prices remain subdued for years at a stretch. Apart from general economic conditions, the value also depends on local factors, such as the local economy, location of property, flow of migrants, etc. What this means is, if there are favourable changes in the location of your home, such as the starting of a new business district, industrial SEZ, etc., your home equity is bound to appreciate.
Home loan amortisation schedule
The next important factor is the home loan payment schedule. As you pay your EMI, your home equity increases. At different periods of your loan tenure, your home equity is different. Deduct the loan outstanding values indicated in your amortisation chart at the end of each year from the prevailing market price of your property to arrive at your home equity at that point. Once you make the last EMI payment, you own the home 100%, and if the current market value is Rs 50 lakh, your home equity is Rs 50 lakh.
Almost all banks or financial institutions appoint an appraiser to calculate home equity. The appraiser considers many factors (apart from the ones mentioned above) before arriving at the fair market value of the property.
Importance of home equity
Home equity helps you when you have additional loan requirements. For example, banks usually define a loan-to-value ratio for borrowers. The amount of loan should not exceed the LTV ratio of the value. Suppose this ratio is 80% for the lending bank. This means you can have a maximum loan of 80% of your current value of home.
Continuing with our example, the maximum loan amount comes to Rs 40 lakh. Since your loan outstanding is already Rs 30 lakh, you can only borrow up to Rs 10 lakh.
Despite your eligibility to borrow based on your home equity, banks will still consider your capacity to repay the loan. If you have erratic regular income or temporary job, banks can still reject your loan application.
How to improve your home equity
While real estate market depends on external factors, homeowners can take some steps to enhance the value of their home, thus increasing home equity, One must ensure that all internal things like water flows, taps, and electric wiring are in good condition. Clean your lawn and keep it in good condition. Work on your home interiors. There are companies that can remodel your kitchen or the whole house to make it look spacious. Use them if you are unsure about home improvement techniques.
The other important thing is downpayment. Initial downpayment reduces the loan amount taken to buy the property. This is the first step towards building home equity. Making a bigger downpayment helps you build a home equity in the same proportion. For example, a 30% downpayment gives you 30% of the home equity at the time of buying. This also reduces your EMI. You can use this savings to prepay some part of the loan outstanding, further enhancing your home equity.
The writer is CEO, BankBazaar.com