Most consumers believe that if you want to build real wealth - you need to have a high salary or a hand-out from your rich parents. But many homeowners don’t realize that they can build using a huge untapped asset - the equity in their home. Building equity in a home is a good thing because there are many ways to use your home’s equity.
Depending on your needs, goals, and how much equity you already have, you can take leverage one of the many products on the market. Read below to learn how to use home equity to make more money and build a solid financial future.
Understanding home equity
To calculate your home’s equity, figure out the value of your home and then subtract the remaining balance on your mortgage. Your home’s value can change depending on the time of year and property value trends in your area. It also varies based on the size of your down payment and how long you’ve been making mortgage payments.
For example, if you recently bought your home and only put down 5%, you have little home equity. But if you’re 20 years into a 30-year mortgage and home values have risen steadily, then you likely have a great deal of home equity.
It’s possible to be underwater or have negative equity in your home, which means you owe more than the home is worth. This can happen if property values drop suddenly. Fortunately for homeowners, home values generally rise over time. Values have risen by 4.3% annually since 1991 and by 7.7% annually since 2012.
How to use home equity to build wealth
You can tap your home’s equity for a variety of reasons. Here are the most common ways you can use home equity to improve your income or increase your assets.
After taking out a home equity loan, you can use the cash as a down payment on another property. There’s no limit on what you can use the funds for as long as it’s a legal venture. This strategy is popular with aspiring landlords or determined handymen who want to purchase a run-down home and flip it for a profit.
By using your home equity, you can buy a property much sooner than if you waited to save up for a down payment.
Because it’s difficult to qualify for a business loan without a current source of revenue, a home equity loan may be one of the few options available for someone looking to raise enough capital to start a business.
Fledgling entrepreneurs can use a home equity loan to buy business tools and equipment, pay for marketing or hire employees.
If you have high interest debt, you can use your home equity to pay off the balance. Home equity loans usually have lower interest rates than credit cards and personal loans.
Home equity loans also usually have longer repayment terms than debt consolidation loans, so your monthly payments may also be easier to manage.
Instead of taking out student loans, you can initiate a home equity loan and use it to pay for continuing education courses, software bootcamp classes, or a full-fledged degree program.
Interest rates for home equity loans may be lower than rates for student loans. If you’re stuck career-wise, advancing your education can help you get a promotion or land a better-paying job.
Except for stocks, bonds, and other securities, a home is one of the most accessible ways to build generational wealth. When your home is part of an estate plan, your heirs can sell the property and use the proceeds to pay off their own loans, buy their own property or invest for the future.
Make sure to state in your will who will receive your home. If you have multiple beneficiaries, create an estate plan to make dividing the home’s proceeds easier to manage when the time comes.
Assessing your home equity
You can get a basic sense of your home equity by inputting your address on a third-party real estate site like Zillow or Redfin. Just be aware that your home's value may be slightly inflated on these sites. You can also ask your former real estate agent for their professional opinion.
Next, calculate your home’s equity by comparing the value to the remaining mortgage balance. If you have more than 20% equity, you may be able to leverage it to build wealth.
Leveraging home equity: strategies and options
Home equity loan
A home equity loan is an installment loan that uses your home’s equity as collateral. Home equity loans have repayment terms usually ranging from five to 30 years. Rates for home equity loans are usually fixed, which means payments will remain the same during the entire term.
Home equity loans can be used for necessary home repairs or remodeling projects, but many homeowners use the funds to pay for education expenses, invest in a new business or buy more property.
Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit (HELOC) is a line of credit, which means you can draw upon it whenever you want to. Need a new roof? Use your HELOC. Want to fund a business venture to increase your income? Using a HELOC to build wealth is a viable solution. Pay for your child’s college education? Yep, you can use the HELOC.
The draw period usually lasts between five and 10 years. You can use as much or as little as the draw amount as you want, so it’s much more flexible than a home equity loan.
Unlike a home equity loan, a HELOC has a variable interest rate, which means payments may differ over time. If overall rates go up, then the rate on your HELOC will also increase. This could be potentially devastating if rates skyrocket beyond what you budgeted for.
A cash-out refinance is when you refinance your home loan and remove the extra equity as a lump sum. Funds from a cash-out refinance can be used for anything, including a down payment on another property, start-up funds for a new business or an advanced degree.
With a cash-out refinance, you’re replacing your existing mortgage with a larger loan, which results in a higher monthly payment. Make sure to factor this into your budget if you choose this option.
Home Equity Investment (HEI)
A home equity investment (HEI) means selling a percentage of your home’s equity for a lump sum. Unlike other home equity loan products, you can always get that percentage back by repaying the amount at any point.
You can use an HEI to build wealth, just as you would use a home equity loan or a cash-out refinance.
Building wealth with home equity: A success story
Point customer Yvonne Galletta used a home equity investment to buy an investment property, creating a passive source of income for her retirement years.
She used part of the proceeds from her HEI to help her son buy a home. While some homeowners are hesitant to withdraw against their equity, Yvonne found the experience to be life-changing.
"I look at this as something we earned,” she said. “We earned this through the care of our home, where we live, and how we live - and now we're taking our earnings and will use it for where it's needed in the years ahead. It relieves a lot of burden for families and their future. You can't ask for more, especially when you're a parent."
If you have a huge chunk of equity in your home, you can attain your financial goals by trying one of the strategies mentioned above. If you’re careful and deliberate about using your home equity, you can parlay that money into real wealth that can help your family for decades. Just be aware of the fees and interest charges when deciding whether or not it’s a good idea.