What Is Loan Equity and How Does It Work?

If you’ve ever taken out a mortgage or car loan, you may have heard the term loan equity. But what exactly does it mean? Loan equity is the portion of your property or asset that you actually own, as opposed to what you still owe to a lender. Understanding how loan equity works can help you make smarter financial decisions.

What Is Loan Equity?

Loan equity is the difference between the current value of an asset (like a house or car) and the outstanding balance of the loan you took out to purchase that asset. As you make payments toward your loan, your equity in the asset increases.

For example:

• If you buy a house worth KES 5,000,000 and have paid off KES 1,000,000 of your mortgage, your equity in the home is KES 1,000,000.

In simpler terms, equity is the part of the asset you fully own, while the remaining part is what you owe the lender.

Types of Loans That Build Equity

1. Mortgages Mortgages are the most common type of loan that builds equity. As you pay down your mortgage, your equity in the home grows, especially as the property value increases over time.

2. Car Loans Car loans also help build equity, but vehicles typically depreciate in value. This means your loan balance could be higher than the car's value in the early stages, but as you make payments, you’ll build equity.

3. Home Equity Loans Once you have built up a significant amount of equity in your home, you can take out a home equity loan or home equity line of credit (HELOC). This allows you to borrow against the equity you’ve accumulated, often at lower interest rates.

How to Build Loan Equity Faster

1. Make Extra Payments

By paying more than the minimum required amount, you can pay off your loan faster and build equity more quickly. Extra payments go directly toward reducing the principal balance, increasing your equity.

2. Refinance Your Loan

If interest rates drop, you may want to refinance your loan. This can lower your monthly payments, allowing you to pay off the loan faster and build equity sooner.

3. Increase Property Value

Making improvements to your home or property can increase its value, which in turn raises your equity. Upgrading kitchens, bathrooms, or making energy-efficient improvements can have a significant impact.

The Benefits of Building Loan Equity

1. Access to Borrowing Power

As your equity grows, you can use it as collateral for a loan, such as a home equity loan. This is a low-interest way to access cash for things like home improvements or debt consolidation.

2. Increased Wealth

Building equity over time contributes to your net worth. If you sell your home or car, the equity is yours to keep, and it can be a source of wealth for future investments.

3. Lower Financial Risk

Having equity reduces the risk of owing more than the asset is worth, also known as being "upside down" or "underwater" on a loan.

Pro Tip:

When taking out a loan, always look for ways to build equity faster—either by making extra payments, choosing shorter loan terms, or improving the value of the asset. This can help you save money in the long run and increase your financial stability.

Conclusion

Loan equity is a critical part of any large financial decision, whether you're buying a home or financing a car. By understanding how equity works and how to build it, you can make better choices about your loans and improve your financial future. Are you building equity with your current loans?