Homeownership offers many advantages over renting, including a stable living environment, predictable monthly payments, and the freedom to make modifications. Neighborhoods with high rates of homeownership have less crime and more civic engagement. Also, studies show that homeowners are happier and healthier than renters and their children do better in school. 1
However, one of the best perks of homeownership is the opportunity to build wealth over time. Researchers at the Urban Institute found that homeownership is financially beneficial for most families 2, and a recent study showed that the median net worth of homeowners can be up to 80 times greater than that of renters in some areas. 3
You may be wondering how purchasing a home will help you build wealth and what steps you should take to maximize the potential of your investment.
What is Home Equity?
Home equity is the difference between what your home is worth and the amount you owe on your mortgage. For example, if your home would currently sell for $250,000 and the remaining balance on your mortgage is $200,000 you have $50,000 in home equity.
The equity in your home is considered a non-liquid asset. It’s your money. But rather than sitting in a bank account, it provides you with a place to live. When you factor in potential appreciation, an investment in real estate will likely offer a better return than any savings account available today.
How Does Home Equity Build Wealth?
A mortgage payment is a type of “forced savings” for home buyers. When you make a mortgage payment each month, a portion of the payment goes towards interest on the loan. The remaining payment goes towards paying off the principal, or loan balance. This means that the amount of money you owe the bank is reduced each month. As your balance goes down, your home equity goes up.
Unlike other assets that you borrow money to purchase, the value of your home generally increases (appreciates) over time. For example, when you pay off a car loan after 5 – 7 years, you will own it outright. But if you try to sell it, the car will be worth much less than when you bought it. So when you sell your home, not only will you have grown your equity through your monthly payments, but in most cases, the market value of your home will be higher than what you originally paid for it. Even if you only put down 10% at the time of purchase or only pay off just a small portion of your mortgage, you get to keep 100% of the property’s appreciated value. That’s the wealth-building power of real estate.
What Can I Do to Grow My Home’s Equity Faster?
Now that you understand the benefits of building equity, you may wonder how you can speed up your rate of growth. There are two ways to increase the equity in your home:
1. Pay down your mortgage
Your home’s equity goes up as your mortgage balance goes down. Paying down your mortgage is one way to increase the equity in your home.
Some homeowners do that by adding a little extra to their payment each month. You can make one additional mortgage payment per year, or you can make a lump sum payment when extra income is available.
Another option to pay off your mortgage faster is to decrease your amortization period. For example, if you can afford larger monthly payments, you might want to consider refinancing from a 30-year mortgage to a 15-year mortgage. Not only will you grown your home equity faster, but it could save you a lot of interest over the life of your loan.
2. Raise your home’s market value
Boosting the market value of your property is another way to grow your home equity. While many factors that contribute to your property’s appreciate are out of your control (i.e. demographic trends, the strength of the economy, etc.) there are some things you can do to increase it’s value.
Many homeowners enjoy DIY projects that can add value at a low cost. Some choose to invest in larger, strategic upgrades. Remember, you won’t necessarily get back every dollar you invest in your home. According to Remodeling Magazine’s latest Cost vs. Value Report, the remodeling project with the highest return on investment is a garage door replacement which costs about $3,600 and can be expected to recoup 97.5% at resale. Conversely, an upscale kitchen remodel, which can cost around $130,000, averages less than a 60% return on investment. 4
How Do I Access My Home Equity if I Need It?
When you put money into a checking or saving account, it’s easy to withdrawal it when you need it. Tapping into your home equity is a bit more complicated.
Most homeowners access their equity by selling their home. Many sellers choose to downsize and use the equity to supplement their income or retirement savings. But what if you want to access the equity in your home while you’re still living in it? You might want to finance a home renovation, consolidate debt, or pay for college. To do that you’ll need to take out a loan using your home equity as collateral.
There are several ways to borrow against your home equity, depending on your needs and qualifications. 5
1. Second Mortgage
A second mortgage (also known as a home equity loan), is structured much like to a primary mortgage. You borrow a lump sum amount, which you are responsible for paying back with interest over a set amount of time. Most second mortgages have a fixed interest rate and provide the borrower with a predictable monthly payment. Just keep in mind, if you take out a home equity loan, you will be making monthly payments on both loans.
2. Cash Out Refinance
With a cash-out refinance, you refinance your primary mortgage for a higher amount than you currently owe. You pay off your original mortgage and keep the difference as cash. This option may be preferable to a second mortgage if you have a high interest rate on your current mortgage or would prefer to make just one payment per month.
3. Home Equity Line of Credit (HELOC)
A home equity line of credit, or HELOC, is a revolving line of credit much like a credit card. It allows you to draw out money as you need it instead of taking out a lump sum all at once. A HELOC may come with a checkbook or debit card to easily access the funds. You will only need to make payments on the amount of money that has been drawn. Like a credit card, the interest rate on a HELOC is variable, so your monthly payment may change depending on how much you borrow and fluctuations in interest rates.
4. Reverse Mortgage
A reverse mortgage enables qualifying seniors to borrow against the equity in their home to supplement their retirement funds. In most cases, the loan plus interest doesn’t need to be repaid until the homeowners sell, move, or are deceased. 6
Tapping into your home equity might be a good option for some homeowners but do your research first. Sometimes another loan or financing method may offer a lower interest rate or better terms to fit your needs. It’s important to remember that defaulting on a home equity loan could result in foreclosure. Please feel free to contact us if you would like a referral to a lender or financial advisor.
WE’RE HERE TO HELP YOU
Wherever you are in the equity-growing process, we can help. We work with buyers to find their perfect home so that they can begin their wealth-building journey. We also offer free assistance to existing homeowners who want to know their home’s current market value to refinance or secure a home equity loan.
When you’re ready to sell, we can help you get top dollar to maximize your equity stake.
For all of your real estate related questions, contact:
The above information is for informational purposes only. It is not intended to be financial advice.
Consult a financial professional for advice regarding your individual needs.
- National Association of Realtors
- Urban Institute
- Census Bureau
- Remodeling Magazine