What is Home Equity?
Introduction
Figuring out how to build steady wealth is difficult. We live in wobbly times and the recent pandemic has created an air of uncertainty around many future plans and obvious safety nets that make it difficult to plan for the future. There is one thing that has had staying power: building home equity.
Home equity is great at helping people build wealth, but it also is not an option available to everyone. In this article we explain what home equity is and how it helps people to build wealth. We’ll also look at real world examples of how homeownership over the last 2 years has helped people build wealth, while those without homes have struggled. In the end, we hope to figure out how to bridge the gap, bringing the security of homeownership to more people.
What is home equity?
First things first, it’s important to understand what home equity is. When we talk about home equity, we are referring to the market value of your home minus the amount that you owe on that home.
To put it in even simpler terms, consider this example. Let’s say your house is currently valued at $400,000 in today’s market. So far, you’ve paid $100,00 in mortgage payments on your home. This means that the current balance on your mortgage is $300,000. If you subtract the current balance on your mortgage ($300,000) from your house’s current market value ($400,000), you have $100,000 in home equity. That's it.
How does home equity build wealth?
Equity isn’t money that is technically spendable, but it can be used to help you produce more income for yourself in a few different ways.
Paying off your mortgage is like a forced savings account. Each payment that you make reduces what you owe and, as time goes by, your home increases in value. This means that, in a sense, you are paying a lower price for an asset that will be worth more in the future.
Additionally, as you pay off your mortgage, you own an increasingly larger percentage of your home until that mortgage is totally paid off and you own 100% of that asset. With each payment, you increase your equity and that helps you build your own personal wealth. All in all, the longer you stay in your home, the more likely you are to build equity.
The home equity that you build can be used to build more wealth, as you are able to borrow against the value of your home with a home equity loan or a line of credit. That line of credit can be used to renovate your house to increase its value, or to purchase another property that you can rent out and make passive income off of. Many homeowners use their home equity to help fund their children's higher education, to start small businesses or to invest in other housing opportunities. Recent studies have shown that homeownership results in many positive financial outcomes, including higher savings balances, tax advantages and higher incomes than renters. For those aged 65+, homeowners tended to be worth an average of 44x more than those who rented. Those renters, on average, were only worth about $5200.
Owning a house is a great first step in creating long-lasting, generational wealth and economic stability in both the short and long term.
How have families who own homes built wealth in the last 2 years?
There are specific conditions that have helped families who own homes build wealth over the last two years. The pandemic housing market created conditions where housing is in high demand across the US, but is in short supply. This difference in supply and demand caused housing prices to appreciate at a record-breaking pace.
For those who own homes, they have seen their equity increase at rapid rates. The value of their home has been increasing as they slowly pay down their mortgage, raising their equity. That means that these families have better opportunities to pay for their kids to go to college or start a business or invest in rental properties. In a sense, owning a house before the pandemic has helped many families maintain intergenerational wealth security, or to attain intergenerational wealth for the first time.
For reference, the average homeowner with a mortgage increased their wealth by $67,000 in the past 2 years. And this is not just the super rich in big cities – this includes homeowners in middle-income areas of the Midwest, too. Homeowners everywhere have seen a benefit.
Who was left out?
Those families who do not own houses tell a very different story. In the same way that increases in stock prices only mean something to you if you own stock, these economic conditions in the housing market are only helpful if you own a home. For those who rent, it’s an entirely different story. This is what some economists refer to as the “dual reality.” Simultaneously, homeowners have experienced an overall increase in their net worth, while those who don’t own homes have experienced the exact opposite. For those who don’t own homes, rents and inflation have been rising at rapid rates, which has increased their overall cost of living. This has led to ever-increasing inequality across the board.
In short, their ability to create intergenerational wealth has been diminished.
