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. Additionally, studies
show that homeowners are happier and healthier than renters, and their children
do better in school.1
But one of the biggest 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
So how does purchasing a home help you build
wealth? And what steps should you take to maximize the potential of your
investment? Find out how to harness the power of home equity for a secure
financial future.
WHAT IS
HOME EQUITY?
Home equity is the difference between what
your home is worth and the amount you owe on your mortgage. So, for example, if
your home would currently sell for $250,000, and the remaining balance on your
mortgage is $200,000, then you have $50,000 in home equity.
$250,000 (Home’s
Market Value)
- $200,000
(Mortgage Balance)
______________________________
$50,000 (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’s providing you with a place to live. And when you factor in the potential
of 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 money goes towards interest on your loan, and the remaining part goes
towards paying off your principal, or loan balance. That means the amount of
money you owe the bank is reduced every month. As your loan balance goes down,
your home equity goes up.
Additionally, unlike other assets that you
borrow money to purchase, the value of your home generally increases, or
appreciates, over time. For example, when you pay off your car loan after five
or seven 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. However, when you purchase a
home, its value typically rises over time. So when you sell it, not only will
you have grown your equity through your monthly mortgage payments, but in most
cases, your home’s market value will be higher than what you originally paid.
And even if you only put down 10% at the time of purchase—or 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 basic ways to increase the equity in your home:
1) Pay down your mortgage.
We shared earlier that your home’s equity goes
up as your mortgage balance goes down. So paying down your mortgage is one way
to increase the equity in your home.
Some homeowners do this by adding a little
extra to their payment each month, making one additional mortgage payment per
year, or making a lump-sum payment when extra money becomes available—like an
annual bonus, gift, or inheritance.
Before making any extra payments, however, be
sure to check with your mortgage lender about the specific terms of your loan.
Some mortgages have prepayment penalties. And it’s important to ensure that if
you do make additional payments, the money will be applied to your loan
principal.
Another option to pay off your mortgage faster
is to decrease your amortization period. For example, if you can afford the
larger monthly payments, you might consider refinancing from a 30-year or
25-year mortgage to a 15-year mortgage. Not only will you grow your home equity
faster, but you could also save a bundle in 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 appreciation are out of your control (e.g. demographic trends
or the strength of the economy) there are things you can do to increase what
it’s worth.
For example, many homeowners enjoy
do-it-yourself projects that can add value at a relatively low cost. Others
choose to invest in larger, strategic upgrades. Keep in mind, you won’t
necessarily get back every dollar you invest in your home. In fact, 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 $3600 and is expected to recoup
97.5% at resale. In contrast, an upscale kitchen remodel—which can cost around
$130,000—averages less than a 60% return on investment.4
Of course, keeping up with routine maintenance
is the most important thing you can do to protect your property’s value.
Neglecting to maintain your home’s structure and systems could have a negative
impact on its value—therefore reducing your home equity. So be sure to stay on
top of recommended maintenance and repairs.
HOW DO
I ACCESS MY HOME EQUITY IF I NEED IT?
When you put your money into a checking or
savings account, it’s easy to make a withdrawal when needed. However, tapping
into your home equity is a little more complicated.
The primary way homeowners access their equity
is by selling their home. Many sellers will use their equity as a downpayment
on a new home. Or some homeowners may 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? Maybe you want to finance a home
renovation, consolidate debt, or pay for college. To do that, you will 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
similar to a primary mortgage. You borrow a lump-sum amount, which you are
responsible for paying back—with interest—over a set period of time. Most
second mortgages have a fixed interest rate and provide the borrower with a
predictable monthly payment. Keep in mind, if you take out a home equity loan,
you will be making monthly payments on both
your primary and secondary mortgages, so budget accordingly.
2) Cash-Out Refinance - With a cash-out refinance, you refinance your primary mortgage for a
higher amount than you currently owe. Then 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 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, similar to 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 enable easy access to funds. You will
only need to make payments on the amount of money that has been drawn. Similar
to a credit card, the interest rate on a HELOC is variable, so your payment
each month could change depending on how much you borrow and how interest rates
fluctuate.
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 may be a good
option for some homeowners, but it’s important to do your research first. In
some cases, another type of loan or financing method may offer a lower interest
rate or better terms to fit your needs. And it’s important to remember that
defaulting on a home equity loan could result in foreclosure. Ask us for a
referral to a lender or financial adviser to find out if a home equity loan is
right for you.
WE’RE
HERE TO HELP YOU
Wherever you are in the equity-growing
process, we can help. We work with buyers to find the perfect home to 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. And when you’re ready to sell, we can help you get
top dollar to maximize your equity stake. Contact us today to schedule a
complimentary consultation!
The above references an opinion and is
for informational purposes only. It is not intended to be financial advice.
Consult a financial professional for advice regarding your individual needs.
Sources:
1. National Association of
Realtors -
https://www.nar.realtor/blogs/economists-outlook/highlights-from-social-benefits-of-homeownership-and-stable-housing
https://www.nar.realtor/blogs/economists-outlook/highlights-from-social-benefits-of-homeownership-and-stable-housing
2. Urban Institute -
https://www.urban.org/urban-wire/homeownership-still-financially-better-renting
https://www.urban.org/urban-wire/homeownership-still-financially-better-renting
3. Census Bureau -
https://www.census.gov/library/stories/2019/08/gaps-in-wealth-americans-by-household-type.html
https://www.census.gov/library/stories/2019/08/gaps-in-wealth-americans-by-household-type.html
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