Understanding how home equity works isn’t as difficult as it might seem, but the numbers and calculations involved can be complicated. Essentially, if you make payments on a loan you took out to buy a house, you gradually acquire a larger share of ownership from the lender as you pay down the debt. That increasing share of ownership in the property is your home equity.
So how else does equity build on a home? Paying down your loan’s principal isn’t the only way for you to boost your equity; gains also come from any increase in the home’s value. And if you’ve purchased a well-built home in a desirable location, its value will nearly always increase over time. If you don’t know how to work out the equity in your home, the equation is simple: Just subtract your remaining debt on your mortgage from your home’s current market value.
The lending market of the last few years boosted United States homeowners’ total home equity by $636 billion in 2018, and the average homeowner with a mortgage recently saw equity gains of around $4,900 over the last year. With the market of the near future expected to remain relatively calm, mortgage interest rates should remain close to their current three-year lows. It’s not a bad time to buy or borrow if you’re looking to build equity in a home and safeguard your financial future.
Creating an Informed Strategy
Despite the sunny outlook on homeownership, your homebuying strategy should still be well-informed. Understanding your market’s property values and how they can influence your equity-building potential is key.
A home’s market value can be influenced by school district zoning, local business growth, civic amenities, regional development, and many other variables. All of these interconnected factors mean expert guidance goes a long way toward making a wise home investment.
You might think your home’s value will be at the mercy of market winds, but there’s one factor you can control: The improvements you make in your home.
If you make an investment in your property that increases its market value — say, adding new countertops in your kitchen or repaving your driveway — you also build your home equity. Home renovations, improvements, remodels, and additions are very reliable ways to increase your property value (and, therefore, your total home equity).
However, there are other ways to make home equity work for you, including using your preexisting home equity to build home equity. We’ll cover that in depth below.
Wealth-Building and the ‘Forced Savings’ Mindset
The typical U.S. household has liquid savings of around $9,000, but this number varies significantly by age group, marital status, and presence or absence of children. Couples aged 34 or younger with no children have an average of $4,727 in savings, for instance, and childless singles in the same age group have just $2,729 stored away.
Regularly funneling money into a savings account can be difficult for many people. Savings that do accrue are often used for vacations or emergencies, meaning the funds can disappear in an instant. So is there a more reliable and accessible means of wealth-building? And is it possible to charm two birds with one seed as you build that wealth?
As it turns out, making regular mortgage payments is among the surest ways to build wealth and make home equity work for you. In this sense, building equity in your home is like investing in bonds or other long-term financial products: A portion of your mortgage payments can be considered “deposits” into a “forced” savings account that yields wealth by growing home equity over the years.
The best part? You build equity in your home while enjoying it, and part of that enjoyment will come from the home improvements you make.
Let’s say you purchase a $150,000 house and decide to upgrade the kitchen and windows. Maybe you’ll build a deck or add a swimming pool. Depending on how you decide to invest and boost the value of your hypothetical home, you allocate $50,000 in home improvements over 20 years.
Without considering depreciation or other possible value-influencing market factors over those two decades, you should be able to sell the home for at least $200,000 to recoup your investment. That’s because $50,000 in upgrades will figure evenly and handsomely into the new appraisal value.
But this is just one more way to make home equity work for your long-term financial goals. When you build equity in a home by paying down your mortgage balance, you can also use the home equity itself to finance not just improvement projects — but anything else you’d like. The more ownership and value you can lay claim to, the more flexibility you’ll have.
Doing More With Equity in Your Home: The Power of Personal Relationships
Despite what you might have heard about the digital age depersonalizing banking, research suggests that people still strongly value personal relationships. This is especially true when it comes to something as personal as building home equity.
People love the speed and convenience of everyday online transactions, but they prefer close relationships when it comes to larger, more complicated offerings. This means that when you’re looking to start building your home equity, it’s critical to work with a lender who’s available to chat in person. If you call the lender’s office, he or she should be able to answer the phone or return your call promptly.
You probably won’t receive this kind of treatment at large financial institutions. Clients with questions related to their home equity are often referred to remote call centers. The agents handling those calls have no rapport with the client and aren’t likely to understand that client’s personal situation. That kind of fleeting, impersonal relationship is especially unhelpful when you’re making decisions as big and involved as buying and building equity in a home.
That’s because buying a home might be one big event, but it’s often just a step in service of larger investment goals. The process of building equity in your home probably involves a decades-long promise to pay down your mortgage, so you’ll need the assurance that your lender has long-term success in mind.
In short, you want relationships with highly specialized experts who will go to bat for you when it’s time to make important decisions about your financial future. This is more common with local lenders who are familiar with the market you’re in and have locations around town that you can visit physically. This kind of genuine human connection makes all the difference.
What Is a Home Equity Line of Credit Used For?
By now, you understand what you can do with equity in your home: You know how to build equity in a home and how to make that home equity work for you. Let’s take a look at what else you can do with the equity in your home and what a home equity line of credit — or HELOC — is
A HELOC provides even more avenues for you when it comes to building up your home equity. In simple terms, it’s a line of credit that’s obtained by your home that offers a revolving credit line. A HELOC functions similarly to a credit card in that you can access its funds quickly and easily. HELOCs tend to have variable interest rates and no closing costs, and they’re extremely useful given the right conditions
The majority of people secure HELOC loans for home improvement projects that build equity. But some of these projects — think finishing your basement or adding a room — cost much more than others, and paying off their financing will take longer.
At American Bank of Missouri, we advise our clients to avoid using a credit card for these types of large purchases if they can safely borrow against their home equity. Credit cards often have higher interest rates, and the cost of the project itself might even be too high for financing with a credit card. A HELOC is a great way to bypass these issues.
How a HELOC Works for You
Let’s explore how a HELOC works more in depth.
If you apply for a HELOC and are approved, you’ll have a fixed amount to use. Your HELOC credit limit might be set at $50,000 to start, for example. Like a credit card, you don’t have to use all that money at once, and how you withdraw and use funds is your decision.
Depending on your situation, you can even decide to take out a HELOC loan on shorter terms if it works with your overall home equity investment strategy. At American Bank of Missouri, for instance, we find that four out of 10 homeowners pay off their short-term HELOC around the same time they pay off their mortgage. At that point, they own their homes free and clear. On the other hand, you might prefer to explore the benefits of longer-term HELOC loans if you have the home equity to secure one.
Again, you can use your HELOC funds as you see fit. Because a HELOC is simply a lower-interest line of credit, you can use it for everything from consolidating credit card debt to buying hunting property.
However, remember that leveraging too much of your home equity to consolidate debt at one time can be risky. If market conditions become unfriendly, the HELOC variable interest rate can go up, meaning higher payments. And if the market is in bad enough shape, the value of your house can go down — leaving you owing more than it’s worth.
Still, the benefits of HELOC loans far outweigh the risks given that you use your funds wisely. The right lender can help you strike that balance.
Why Having a Relationship-Based Lender Matters
If you call a large national bank and inquire about HELOC options, you’ll probably be connected with someone three states away who’s working in a cubicle. And in the case that you make an appointment to talk with someone locally, that individual is more likely to give you answers from a script.
At American Bank of Missouri, we find that a relationship-based approach with our clients makes a difference in guiding them through the homebuying and home equity process. After all, providing thoughtful, comprehensive service starts with knowing our clients as individuals.
In every meeting, our clients ask and answer questions. This gives us a clearer picture of their current scenario and financial goals, and that understanding helps us guide them toward good decisions in homebuying and home equity. Although some people are prepared to take on short-term debt (such as a HELOC), others are more comfortable with different investments. Our job is to help borrowers map out the safest journey based on their unique situations.
For example, you might have recently purchased a home and are interested in applying for a HELOC. However, this probably means you haven’t built enough equity to finance any improvements. Larger banks might turn you away at the door, but we’ll take stock of your situation and try to provide you with the best options. Our hope is that we can work together to improve and ensure your financial health and flexibility. This is a good example of the flexibility a community bank can afford.
We take the time to explore your specific financial picture in detail. Only then do we discuss how home equity could work for you.
That’s certainly the old-school way of banking, but we’ve found that people still want a human connection. If you’re opening a standard deposit account, you can easily do that digitally. That’s a great example of new technology simplifying things for the better.
But if you want to apply for a HELOC and don’t understand its nuances, you don’t just want to speak with someone. You want to talk to someone with authority and knowledge. You likely want to talk with that same person again if you call back. Our ongoing availability and commitment to personal relationships is a point of pride.
To learn more about how building equity in your home works, simply reach out to one of our consumer lending experts. We’re more than happy to answer your questions.
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