Equity may be one of the most misunderstood aspects of your finances, but it is one of the most important aspects as well. Many people seem to think when you make a big purchase it is a sunk cost, meaning it is money you will never see again, but that is not always the case. When you make certain big purchases, or invest, you are actually building equity. The official definition of equity is the difference between the value of an asset and the value of the liabilities of something owned.
How can you build equity? There are three popular ways you can do so.
Many people think of a home as an investment, which is one way to think of it, but not entirely accurate. It is more accurate to say that buying a home is a way to build equity. When you buy your home, you more than likely have to get a loan from a bank to finance the purchase. That means the bank owns a portion of your home. (And, in many cases, the bank owns a majority of the home.) So, when you make loan payments to the bank, you are slowly buying the home from the bank. The more you pay the more of your home you own over time, and actually owning the home means you have equity which is a form of an investment.
Making a sizeable initial down payment on your home is beneficial because the bigger the down payment, the more of the home you own upfront. And if you own more of the home upfront, you have more equity available immediately. Home equity can be used to borrow against down the road, whereas a more typical type of investment cannot.
You can also build equity by making improvements or increasing the value of your home. One way to build equity in your home is by renovating it. Purchasing new appliances, installing new railings on a staircase or completing a bathroom remodel are all ways you can add value to your home. If your home is worth more than what you originally bought it for you now have an opportunity to sell it at a profit at some point in the future. If you sell your home, five years down the road, for the same amount that you bought it for, the bank will take what is needed to finish paying off the loan. So whatever is left over would go to you, minus any other costs, such as a realtor. If you don’t sell for more than your original purchase price you stand to lose money.
Next we have a more typical type of investment, which is one where you purchase a stock or bond and anticipate some kind of return. When you invest in stock that you anticipate getting a dividend from, you are building equity because you are getting more money back from your investment than you put in. Another way you can build equity through investing is by capital gains. A capital gain is when you sell stock that was bought for less than what you sell it for. Forrest Gump got his fortune by investing in ‘some fruit company’ (he was referring to Apple). He bought stock before the company hit it big, then sold the stock afterwards. Investing in this sense can be risky, so either bring in an experienced professional, or make sure you’re well-educated. Not everyone can come out as lucky as Forrest.
Another, but not the most popular (or necessarily the smartest), way to build equity is to do it via automobile purchases. You have probably heard someone say the value of a brand new vehicle is cut in half the moment you drive it off the lot. There’s a reason for that saying! What you can do to help your automobile hold its remaining value is to maintain the vehicle to the best of your ability. Regular and timely maintenance is crucial. Don’t wait too long to get your oil changed. And, if something seems off, or the vehicle is making a concerning noise, have it looked at sooner rather than later in case it needs repaired. A car in good condition has better resale value than a car that is not maintained.
Another method of maintaining good auto value is to do research to learn which makes and models retain their value. There are certain brands that retain their value better than others and any car enthusiast is going to be able to help you choose a car that will retain value. Like you would do if you’re playing the stock market, make sure you find a trusted partner if you’re not very knowledgeable about cars.
And remember, auto equity is going to be more risky and give you less of a return when using it as a way to build equity.
Our last bit of advice for building equity is this: It is always a good practice to avoid taking on unnecessary debt. Accumulating debt always balances any equity you manage to build, so you can wipe out your entire equity balance with one badly managed credit account. That is why keeping a low credit card balance, paying off debt, and limiting the total amount of debt you take on are all additional ways to help build or maintain equity.