Dubai: Buying a home is a dream come true for most people. It’s also a form of a forced savings system, as every instalment made towards the payment of your home helps build home equity.
So, what is home equity?
Equity is the difference between what you owe on your mortgage and what your home is currently worth.
Here’s an example. “If you owe Dh1.5 million on your mortgage loan and your home is worth Dh2 million, you have Dh500,000 of equity in your home,” explained Ayman Youssef, vice president at real estate firm Coldwell Banker UAE.
It is how much you own in your home after subtracting any outstanding mortgage on it; that is, (2,000,000 - 1,500,000 = 500,000), which is the home equity.
Why does home equity matter?
Building home equity is more important for an end-user than an investor, noted Lewis Allsopp, chief executive of Allsopp & Allsopp, a British owned estate agent in Dubai.
“For an investor, putting equity into their property is tying up more of their money. Investors prefer to put as little equity in their property as possible and gain the return on their investment.
“An end-user will benefit from building equity by having less mortgage to pay overtime. Building equity will also allow an owner to get better rates from the bank by having a substantial down payment, which in turn lowers the monthly costs.”
Moreover, having more equity in the property gives the owner better peace of mind that they own a substantial portion of their home themselves and are less susceptible to market fluctuations, Allsopp further explained.
“If the worst was to happen and an owner was forced to sell, having more equity in the home would mean the owner is less likely to have to put cash into the property to sell it if the market value was to drop.”
How to build home equity?
Here are three practical solutions to help you build home equity.
Solution #1: Make a bigger down payment
Paying a larger amount as a down payment increases the equity on the house. Youssef explained that a higher down payment helps to reduce the monthly instalments for home occupiers. “Investors can reduce the risk against price correction in case of any downward trend in the market, so as not to end up in negative equity.”
It is essentially potential indebtedness arising when the market value of a property falls below the outstanding amount of a mortgage secured on it.
Allsopp added, “Investors who put their property on rent, generally, pay off their monthly EMI (equated monthly installment) from the rent money received.
“In such situations, if for any reason the property is not rented, the pressure of paying the monthly instalment is lesser as the value of the instalment reduces by making a higher down payment. Paying a larger chunk of down payment helps investors to absorb the risk of vacancy.
“Always have an emergency fund to cover the instalments for any unforeseen circumstances like unemployment etc.” However, Allsopp further cautioned that making a higher down payment does not guarantee higher home equity as other factors need to be considered.
“So, do a thorough research on the property, understand the price trends, occupancy rates, future supply for similar properties, cost of ownership, etc.”
Zhann Jochinke, chief operating officer at UAE-based Property Monitor. said the overall real estate market conditions could passively affect the property’s amount of equity.
“If the market goes up and the value of the property increases from Dh1 million to Dh1.2 million, then there is an additional Dh200,000 equity in the property, regardless if there is a mortgage or not. On the other hand, if the market goes down and the value decreases from Dh1 million to Dh800,000, then there is a Dh200,000 loss in equity.
“Making an additional payment even once a year can make a big difference, but it depends on the terms of the mortgage. However, additional payments are usually applied 100 per cent as principal (the original sum invested).”
Solution #2: Increase home value with appropriate improvements:
Boost the value of your home with rightly planned improvements that will help raise your property value; Jochinke recommended the following tips to consider for home upgrades and improvements.
Tip #1: Don’t over-improve.
Always plan to renovate in line with other properties in the community or building. Spending Dh1 million on renovating may not translate to an increase in the property value by Dh1 million.
Tip #2: Focus on improvements to the kitchen and bathrooms first.
Typically, upgrading these parts will add the most value and separate your property from neighbouring properties with their stock standard kitchen and bathrooms. With bathrooms, avoid removing the bathtub from the bathroom by the bedroom that would most likely be for children. Keeping a bathtub in these cases in a family home (especially villas and townhouses) is essential.
Tip #3: Pools can be a great addition, but bear in mind the plot size.
Avoid using too much of the outdoor space for the pool and leaving too little for grass, landscaping, etc. A basic guideline for a smaller plot would be to keep the pool to one-third or less of the backyard area.
Tip #4: Clearly understand, who are you renovating for?
If you’re renovating for yourself with a long-term outlook of staying in the property, your renovations can be more suited to your taste. However, when renovating to sell in the near term and get a return on your renovation investment, upgrade to the likes of the mass market with finishes that will appeal to the broader market.
Tip #5: Increase the built-up area.
If your villa or townhouse has a layout and plot area that allows for additional rooms, these can be great ways to increase equity. An extra bedroom or office is ideal, especially these days with people wanting more livable space. However, avoid converting rooms without adding additional square footage.
For example, if you have a 400 square-feet living room, putting up a wall to make an extra bedroom of around 150 square-feet and reducing the living room to 250 square-feet might seem like a good idea but rarely works out well in the resale market or for the overall value of the property.
Solution #3: Refinance to improve equity:
Refinancing is a great route to help improve equity. Jochinke said one might consider refinancing when the mortgage interest rates are lower than your existing mortgage.
“The costs that come with refinancing should not eliminate the saving of the lower interest rate. For instance, some of the following fees will apply in many refinancing situations: One, an early settlement fee on your current mortgage, secondly, an origination fee on the new mortgage, thirdly, a valuation of the property,” he added.
Here is an illustration to explain the above cost and gain scenario in refinancing a mortgage:
If lowering the interest rate equates to a Dh50,000 savings over the life of the mortgage and the costs to refinance are Dh15,000, then refinancing would make sense.
However, if the interest rate savings were only Dh25,000 over the life of the loan, then refinancing to get Dh10,000 in savings may not make much sense. Likewise, if the costs to refinance were higher than the Dh15,000 considered above, then the benefits of refinancing are outweighed.
1. Know your credit score
Credit scoring is a relatively new component of lending in the UAE. Depending on how good a person’s credit score is, it may affect the interest rate the bank is willing to provide. A higher credit score may result in a lower interest rate being offered by the bank.
2. Employment period
The length of employment and who you are employed by could affect the interest rate; a shorter work period may result in a higher interest rate. Many banks have an approved list of companies, and if your company is on this list, you will likely be offered a better rate than a company that is not on the bank’s list.
3. Having another account with the bank
Most banks will offer an additional 0.25 per cent or similar interest rate reduction if you have a current account with the same bank, where your salary is deposited each month.