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. Your money is, for the most part, locked up and not spendable.
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.
It seems simple enough, but home equity is not guaranteed. Just ask any homeowner who went through the last housing bust. That’s when home equity fell sharply for many homeowners — and, in some cases, completely disappeared.
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.
How do you find out how much equity is in your home?
A home equity calculator can give you an idea of what your home is worth and how much equity you may have, if you’re thinking about selling your home or borrowing a chunk of your equity.
An appraisal will really nail down the value of your house.
» MORE: How to determine home value
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.
Home equity takes time to build
Another nutrient helping to grow home equity wealth is time. Homeowners who stay in their homes longer are more likely to accrue equity.
In the second quarter of 2017, people selling their homes had lived there an average of more than eight years. That was the longest ownership period since Attom began tracking homeownership tenure in 2000. Before the recession, people were staying in their homes an average of about four and a quarter years, Attom data show.
“That’s a paradigm shift — a more conservative approach to homeownership and building wealth through homeownership,” Blomquist says.
Just 10% of homes owned for less than one year are considered equity rich, according to ATTOM.
You don’t have to sell to tap the profit inside your home. Instead, you can borrow against that value with a home equity loan or line of credit. A home equity loan will provide you a lump sum; a HELOC allows you to draw on the available balance as you wish.
Home equity is not a get-rich-quick scheme
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.’"