It is often said that homeownership builds wealth. So, what is home equity, and how can it enhance your net worth?
What is home equity?
Home equity is the current market value of your home, minus what you owe. You’re looking for a positive number. Any gain comes from:
- Paying down the principal balance on your loan.
- An increase in market value over time.
How does home equity work?
Building home equity is a bit like investing in a long-term instrument, like bonds. There are some ways to tap it, but wealth is created over years as your share of “free and clear” ownership of the house increases.
As a rule, building home equity is a slow climb, at best. U.S. residential year-over-year home price appreciation averaged 1.89% from 1997 to 2017, adjusted for inflation, according to CoreLogic, the Bureau of Labor Statistics, and the Urban Institute.
However, behind that average are some major year-over-year price swings during the same period, ranging from a gain of 12.6% to a drop of 18.1%, according to the Urban Institute.
When it comes to short-term home appreciation, sometimes it’s more of a bungee jump than a climb.
Why is home equity important?
Home equity can be a long-term strategy for building wealth. Mortgage payments reduce what you owe while your home gains value, so paying on a house has been called “a forced savings account.”
Home equity can be a long-term strategy for building wealth.
This is unlike virtually every other asset purchased with a loan, such as vehicles, which lose value while you pay them off.
A growing number of U.S. homeowners are amassing “impressive stockpiles” of home equity wealth, according to Daren Blomquist, senior vice president at Attom Data Solutions. At the end of the second quarter of 2017, over 14 million U.S. properties were considered “equity rich” — meaning the debt on the property was 50% or less of the home’s current market value. That’s about 24% of all owner-occupied homes with a mortgage.
Building home equity is definitely a long-term proposition. Blomquist says wise words from one of his relatives may state it best. “My wife’s great-grandfather — who bought property in Southern California a long time ago — his advice was, ‘You take care of a piece of real estate for 20 years, it’ll take care of you forever.’”
Source: Nerd Wallet