If you’re like most American families, your home makes up the predominant slice of your household wealth. Americans have more money in home equity than they do in their retirement accounts or in most of their other assets combined1; they also have more equity than ever - almost $15 trillion worth2.
For many, the biggest benefit of home ownership is forced savings. You save for a down payment, which means you start with equity, and if you don’t have an interest-only mortgage, you add to your equity with every mortgage payment. Remember equity is the part of the home that you actually own (Value of home - what you owe = equity).
Equity is your money and with the right planning can be leveraged to help your bottom line.
- Increase the value of your home
The number one way people use their home equity is for home improvements and repairs3. In most instances, these are great uses of home equity. Repairs are often necessary and if not completed could cause your home value to drop. Home improvements can run the gamut from changes that you and family will love but don’t add that much value to upgrades that definitively improve the value of your home beyond your investment. Remodeling magazine’s Cost vs. Value Report can help you determine the biggest value-add improvements for your area.
One huge reason to use your home equity rather than a credit card or personal loan for improvements is the tax advantage. While there are more restrictions on this benefit now than there were a couple years ago, home equity debt still has tax benefits than can effectively reduce the cost of home improvement projects.
- Pay off debt at a lower interest rate
The second most popular reason homeowners draw on their home equity is to consolidate debt1 and for good reason. By tapping into your home’s equity, you can consolidate multiple debts into one easy and affordable monthly payment with a clear debt-free date. Not only that, because home equity loans are secured by real property (your home), lenders are able to charge significantly lower interest rates than with other forms of debt, such as personal loans or credit cards. This means more of your money goes to paying off your debt than it does to paying interest.
- Use as a smart alternative to high-interest credit cards and personal loans
Maybe you don’t have any credit card or personal loan debt. That doesn’t mean there won’t be instances where you would naturally turn to them. What would you do if you needed to replace your HVAC system? Or pay for significant medical expenses? These are charges that many would pull out a credit card for, but could turn to their home equity to pay.
- Help cover school expenses
Our Head of Wealth and Asset Management loves to discuss the gap in college funding. According to Sallie Mae, 47 percent of college costs were covered by family income and savings. But with college costs increasing at an average of 5 percent a year4, this number is likely to shrink significantly as more families turn to borrowing. Currently, the Direct PLUS Loan for Parents offers a 7.6 percent rate on their loans. For many families, home equity will offer better rates and larger loan amounts.
- Supplement retirement income
The average 65-year-old has 47% more mortgage debt than 65-year-olds had in 2003, according to the Federal Reserve Bank of New York5. Still, after factoring in home equity many retirees could be far better prepared for retirement than they thought. The most well known (though likely not the best) way to leverage home equity for retirement is a reverse mortgage, but there are actually a number of ways to use your equity to supplement retirement income.
Selling is the most clear cut way to access the entirety of built up equity. Homeowners can sell and use some of the equity to purchase a smaller home or move in with family and the rest for their expenses or investments.
For those people who don’t want to move, they can open a home equity line of credit to cover monthly shortages or surprise expenses. Or, if they need access to more cash, there are programs, like Figure’s Home Lease Back, in which homeowners can sell their home but remain living there. The equity can be used for monthly expenses or invested for potentially larger returns.
- Invest for higher returns
For most people, it’s probably not the best idea to pull your equity out to invest. But for some this choice can lead to big gains. People have successfully leveraged their home equity to start businesses and buy investment property. While some have likely used their home equity to add to their stock portfolio, this is one of the riskiest things you can do, and we feel strongly that you should not even consider this an option
- Buy a new home
On average, home values have been surging across the country6, but if you look more closely, some areas are increasing at a much quicker pace than others, and some zip codes are even declining. For people wanting to keep their money in their home, but want it to grow more quickly, they could consider selling and purchasing a home in quicker-appreciating neighborhood. This option is still risky, however, as there’s no guarantee that past appreciation rates will continue and there are costs associated with selling and moving.
How not to use your home equity
Please don’t read this and think it’s smart to use your home equity for everything. You must remember that when you take a loan against your home equity, you are putting your house up as collateral, which means if you have trouble paying back your loan, the lender could take your home.
It is wise not to use your home equity for any unnecessary expenses. That means luxury vacations, boats, cosmetic surgery and the like should be covered in a different way – ideally with budgeted savings.
1. U.S. Census Bureau, Survey of Income and Program Participation, 2014 Panel, Waves 1 and 2
4. The College Board®