How to use home equity to build wealth

Most Americans believe that if you want to build real wealth - you need to have a high salary or a hand-out from rich parents. But the average homeowner has another valuable tool they can use to gain financial freedom - home equity.

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Depending on your needs, goals, and how much equity you already have, you can leverage one of the many products on the market. Read below to learn how to use home equity to build wealth.

Home equity: a brief overview

Home equity is the portion of your home that you own outright. To calculate your home’s equity, figure out the value of your home and then subtract what you owe on your mortgage or any other debts tied to the property. 

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Building equity in a home is a good thing because it allows you to take an asset—your home’s wealth—and make it liquid (easily accessible) when you need it most. When you have sufficient equity, you can use a variety of financial tools to borrow against your home equity and accomplish your goals.

How to use home equity to build wealth

Here are the most common ways you can use the equity you've built to improve your income or increase your assets.

Pay off debt

If you have high-interest debt, you can use home equity to settle the balance. Paying off credit card debt or personal loan debt using an equity product tends to provide lower interest rates and longer repayment terms. As a result, your monthly payments may also be easier to manage.

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Benefits:

• Improved credit score: Paying down debt can improve your credit score, opening up future opportunities for investment or financing at better rates.
• More disposable income: With less debt and extra money, you can invest or save more effectively, ultimately accelerating wealth-building.

Make home improvements

Using your home equity to fund renovations or improvements can increase the market value of your home. When it comes time to sell or downsize, you can yield a higher return on your investment. It can also boost your slice of equity, allowing you access to even more funds should you decide to leverage it in the future.

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Benefits:

• Increased resale value: Strategic home renovations can yield higher returns when selling.
• Potential to save: Energy-efficient upgrades like solar panels offer the opportunity to reduce utility costs and may offer tax incentives.

Invest in real estate

You can leverage equity to purchase an investment or rental property. Depending on how much equity you own, you can cover a down payment or even buy the property outright.

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This strategy is popular with aspiring landlords or determined handymen who want to tackle a fix-and-flip project 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.

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Benefits:

• Rental income: Provides a passive income stream.
• Appreciation: Real estate generally appreciates over time, growing your net worth.

Start or grow a business

Because it’s difficult to qualify for a business loan, home equity financing may be a strategic option for someone looking to raise enough capital to start or grow a business.

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Fledgling entrepreneurs can use home equity financing to cover business expenses, like buying tools and equipment, paying for marketing, or hiring employees.

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Benefits:

• Ownership and control: A business can potentially provide both short-term income and long-term wealth through equity.
• Tax advantages: Many business-related expenses are tax-deductible, potentially reducing your overall tax burden.

Invest in education or skill development 

Instead of taking out student loans, you can use equity to pay for continuing education courses, software boot camp classes, or a full-fledged degree program. Using home equity to invest in your education or learn new skills can lead to higher-paying job opportunities or help you enter a new, more lucrative career.

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Additionally, interest rates for home equity products may be lower than rates for student loans.

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Benefits:

• Higher earning potential: Advanced degrees or specialized skills can increase salaries.
• Career advancement: Skill development can position you for promotions or opportunities in high-demand industries.

Diversify your portfolio

Investing is a popular way to build wealth. Liquidating your equity to diversifying into stocks, bonds, or mutual funds offers the potential for higher returns over the long term compared to simply holding equity in your home. It can also help you hedge against inflation.

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However, it's important to be cautious and consider speaking to a financial advisor, as the market comes with risks.

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Benefits:

• Compound interest: Investing allows your money to grow exponentially over time due to compound interest.
• Portfolio diversification: Investing home equity in stocks or bonds spreads risk across different asset classes.

Create generational wealth

Building generational wealth involves using your equity strategically to benefit not just yourself but future generations. This can be done through investing in assets that appreciate over time and passing those assets down or establishing trust funds and estate planning strategies.

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Benefits:

• Property inheritance: Real estate can be passed down to heirs, providing them with a valuable asset and possibly rental income or appreciation.
• Education funding: Use home equity to cover education-related expenses for children or grandchildren, setting them up for long-term career success.
• Trusts and estate planning: Establishing trusts ensures that your assets, including real estate, are passed on tax-efficiently and according to your wishes.

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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 5 to 30 years. Rates for home equity loans are usually fixed, which means payments will remain the same during the entire term.

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‍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.

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The draw period usually lasts between 5 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. The repayment period is generally 20 years. During this phase, you’ll be responsible for monthly payments for principal plus interest. 

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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.

Home Equity Investment (HEI)

A home equity investment (HEI) provides a single lump sum payout in exchange for a slice of your home’s future appreciation. There are no monthly payments, rather, the investment is settled anytime during a flexible 30-year term. 

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Unlike home equity loans or HELOCs, HEIs have less stringent requirements. You’ll need a credit score above 500, sufficient equity, and a home in an eligible zip code to qualify. There are no income requirements, which makes it a valuable tool for low-income earners, retirees, or self-employed individuals with fluctuating incomes. 

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There are no restrictions on how you can use the funds, so you can use an HEI to build wealth, just as you would use a home equity loan or a cash-out refinance.

Cash-out refinance

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.

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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.

Final thoughts

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.