The big reason homeownership is the American Dream is that it is the most straightforward path to building wealth for the average American. Today’s skyrocketing home values have resulted in 42% of homeowners with mortgages being “Equity Rich” at the end of 2021 (according to Attom real estate data). There is another 38% who own their homes free and clear (according to Census Bureau data). In total, that is an incredible amount of equity wealth.
According to Black Knight’s Mortgage Monitor, there is currently a record total of $9.9 trillion in available equity, which is a 35% jump in a single year. The average homeowner now has $185,000 in available equity. Available equity is everything above the 20% usually required by lenders to back a mortgage.
The path to building equity wealth is not complicated. Equity wealth is simply the amount that the homeowner owns outright. When there is a mortgage, homeowner equity is the difference in the value of the home minus the balance still owed on the mortgage (the balanced owed includes second mortgages and other mortgage-backed loans). To calculate your home equity, take the current market value of your home and subtract it from what you still owe on your mortgage.
The key is that equity is based on the value of the home, not the outstanding mortgage balance owed. Much of today’s equity wealth has resulted from annual home price gains that averaged 15% in 2021, and 6% in 2020 (a continuing trend). There are generally three ways to increase the equity in your home:
Increasing market value is something you have little control over, other than buying in highly sought-after neighborhoods. Typically, these are neighborhoods with a strong economic foundation, good schools, low crime, desirable amenities, etc.
Paying down the principal is what homeowners do every month when they pay the mortgage. There are ways to accelerate this using 20- or 15-year mortgages or by paying more than the required payment each month.
Increasing equity through home improvements is more challenging. While most home improvement projects do add value, often the value added is less than the cost of the improvement. Home improvements can add to the overall market value but adding improvements beyond what is typical in the neighborhood may not be effective financially.
Generally, equity wealth and rising home prices are considered to be good things for homeowners and the economy but there is one negative to keep in mind. Higher home prices mean paying more in annual property taxes. This has the most impact in states with the highest property tax rates. Property taxes can be minimized by appealing property tax increases as well as senior and low-income discounts.
There are several ways to access your home equity to turn it into cash. However, there are usually substantial refinancing charges involved. For that reason, equity financing is most often used for large ticket items like higher education, debt consolidation, home renovations, and new car purchases. The most common methods of accessing homeowner equity are:
Cash-out Refinance. This is used when you want to both refinance into a lower interest rate and take out cash at the same time. Typically, you can cash-out up to 80% of the market value of the home. At the same time, you replace your old mortgage with a new and larger mortgage based on the current market value.
Home Equity Lines of Credit (HELOC). Here you can gain access to much as 85% of the home’s value. This works more like a credit card because you don’t take the money as a lump sum. Instead, you use a line of credit on an “as-needed” basis. You also only pay interest on the amount that is currently borrowed. These usually come with a variable interest rate instead of a fixed interest rate.
Home Equity Loan. This one is similar to a cash-out refinance except that you do not take out a new mortgage. You receive up to 85% of your home’s value as a lump sum payment. Although you are not taking out a new mortgage, you may be able to renegotiate some of the terms of the loan such as how long you have to repay it.
Reverse Mortgage. These are gaining popularity as our society becomes older. To qualify, you must be at least 62 years old and have a low or no mortgage balance. These loans allow you to borrow against your home value, but you might not ever repay the loan yourself. Instead, when you move or die, your heirs sell the property to repay the reverse mortgage amount.
Homeowners are turning equity wealth into real money. Historically, equity has mostly been treated as a savings account to accumulate wealth. Equity is a spendable asset but not one that can be easily tapped into like a checking account, credit card, or stock brokerage account. However, more people are accessing their equity resulting in a shift to an equity-centric economy.
The second half of 2021 saw more people withdrawing equity from their homes than at any time in the last 14 years. One reason why there might be too few houses for sale is probably because people are taking their gains in cash while continuing to own their homes. This may have been a good wealth-preserving strategy while interest rates were at historic lows. People were able to access cheap money for luxuries and to improve their standard of living. Although they took out substantial loans, these were not nearly at the debt level required to purchase another home. Just because they could take out up to 85% of the equity, doesn’t mean they did.
Equity spending is likely a significant driver of the inflation that we are now seeing. The combination of higher interest rates and higher inflationary costs should slow down equity spending soon. Both cash-out refinancing and home equity lines of credit are now carrying higher interest rates as well buying less as inflation takes its toll.
While it’s true that equity wealth is mostly on paper, with home prices continuing to rise at double-digit rates, more homeowners will continue turning those gains into actual cash - and spending it.
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