Home equity is typically the greatest asset that many American families have, and yet, many families are unaware of all the opportunities to leverage that equity to build wealth. If used properly, however, it’s possible to make this asset work for a family to use the money tied up in a property to build wealth.
Building your home equity is one of the best ways to increase your family’s overall wealth while still being able to enjoy the advantages of owning property. Once you are able to access this equity, you will be able to utilize it for a variety of investment strategies that can be used to increase your total wealth.
Investment Strategies for Building Wealth
Paying off debt
This strategy allows homeowners to pay off debt faster than they would have otherwise, freeing up cash to make other investments. In fact, debt consolidation is one of the most common uses of home equity loans, and for good reason. Interest rates on home equity loans from a respected financial institution can be much cheaper than the rates on a student loan or personal loan. These loans also offer a low fixed interest rate and monthly payment that can help homeowners to save money each month by consolidating debt.
This strategy has gained some popularity in recent years as financial advisors look for sources of capital. With this strategy, the homeowner uses a home equity loan to take out their home’s equity as a lump sum payment. This money is then used to purchase a low-risk investment, such as government bonds, or a financial product such as an annuity.
Bond funds carry a relatively low amount of risk, but can offer returns of around 5% or more. An investor can take a lump sum payment from a home equity loan or cash-out refinance, and purchase shares in one of these funds. Over a period of several years, that total amount earned plus the original principal should be higher than the total amount paid in mortgage payments, as long as the return on the investment is at a higher rate than the interest rate on the loan.
Annuity products typically have a guaranteed interest rate that is higher than the interest rates charged for a home equity loan. Furthermore, the annuity payments are higher than the payments on the loan. This allows investors to pocket the difference between the two payments. Each month the annuity or bond fund will pay several hundred or thousand more than the second mortgage payment on the house. Investors make their mortgage payment from the funds received, then use the remaining funds to pay off other debts, make higher risk (and higher return) investments, or fund their lifestyle.
One of the increasingly popular ways to use home equity to build wealth is to use the money to make a down payment on a second property. Essentially, this method allows people to borrow money for a second property without having to go through the hassle of coming up with a new down payment.
This property can then be used to generate income, which will be used to pay down the mortgage principal on the second property (and build equity), while also providing some amount of cash flow to the investor.
Over time, the home value should increase, providing an investor with the opportunity to use the equity in the second property to make a down payment on a third property. By repeating this strategy across many markets, it is possible to quickly grow a portfolio of multiple properties, giving an investor millions of dollars worth of assets.
Many homeowners have been able to quickly grow their wealth using this strategy. It is important, of course, to take a conservative approach when buying property.
How risky is a home equity loan?
The biggest risk with a home equity loan (second mortgage) is that a person’s home is being used as collateral. In the case of a cash-out refinance with a lower interest rate and longer payment terms, there is hardly any risk. These loans typically come with lower monthly payments, and since the new loan replaces the investor’s old mortgage, there is virtually no additional risk to the investor.
Home equity loans that involve making an additional monthly payment are more of a risk. However, the risks are relatively low as long as you know you can make the payments. Many investors choose to hedge this risk by only taking a small portion of their home equity loan, leaving the rest to be available as an emergency fund.
How does home equity increase?
Home equity will increase every time you make a mortgage payment since a portion of the payment goes towards paying down the principal on the mortgage balance. It’s also possible to increase home equity by making home renovations or home improvements that will increase the home’s value. Finally, homeowners can see home price appreciation by giving the local market conditions time to improve, essentially increasing the home’s current market value.
Is it a good idea to take equity out of your house to invest?
The primary risk with this investment strategy is the possibility that you will be unable to make the second mortgage payment and go into foreclosure. There are multiple ways to mitigate this risk, however. To start, make sure that you have an emergency fund in place to cover a loss of income. If you’re using the loan to make an investment, choose something that is relatively low risk, especially if you plan on using the funds from the investment to cover the payments on the loan.
Can you use the equity in your home for anything?
The answer to this depends on the exact stipulations of the home equity loan you choose. While you can generally take out home equity for anything, the interest rate for one of these loans is only tax deductible if the money is used to improve the home. There is a lot of leeways given in what is considered to be a home improvement, however, and it may be possible to get other tax benefits by investing the money in the right financial product. A cash-out refinance tends to be the best choice for consumers looking to reap the tax advantages of deductible mortgage interest.
How can I use equity to build wealth?
Before securing access to your home equity through a new home equity loan, it’s important to develop an investment strategy.
Start by knowing your financial goals. Any financial advisor will start new clients on this step, regardless of how many assets they have. These goals will help to develop a timeline for your investment, which in turn will be a big part of the risk you’ll need to take. Next, determine your risk tolerance. If you intend to use a portion of your earnings to pay back your home equity loan, then you’ll need to pick an investment that has a high likelihood of producing the income you need, even if it means not investing as aggressively as you would prefer in order to meet your goals faster. Finally, implement your strategy as soon as possible. Market conditions are changing rapidly, and a strategy that could work today might not be the best choice a few months from now.
Use home equity to build wealth for your family
Now that you learned the ins and outs of building equity and using it for wealth creation, the next step is to decide which of these routes is right for you. Even if you choose not to proceed and simply leave your home equity in place, that’s okay too.