How to use home equity to build wealth

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In a Nutshell

If you have a considerable amount of equity in your home, you might be able to take some of it out to invest in wealth-building strategies like starting a business, making home improvements, buying an investment property and more.
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Home equity is the market value of your home minus any debt you owe on it. For example, if your house is worth $300,000 and your mortgage balance is $50,000, then you have $250,000 of equity — as long as there are no other liens against your property.

Your equity generally increases as you pay down your mortgage or if your home value goes up. Let’s take a closer look at how you may be able to increase your home equity and potentially use it to build wealth.

Building equity over time by paying your mortgage

The equity you accrue in your home adds to your overall wealth or net worth, calculated as your assets minus your debts. When buying a home, you can give yourself a head start on building equity by making a large down payment. You’ll grow your equity over time by making your mortgage payments.

If you pay monthly private mortgage insurance (or PMI), contact your lender when your equity reaches 20% to see if you can cancel that premium. You may be able to then put that extra cash toward your mortgage principal each month and build equity more quickly.

Once you’ve built up a significant amount of equity in your home, you may be able to use it to build wealth in other ways, using a home equity loan, home equity line of credit (or HELOC), cash-out refinance or a reverse mortgage (if you’re 62 or older).

Taking out home equity to pay off debt

If you have high-interest debt, student loans, personal loans or auto loans, you may be able to use home equity to pay it off. If your new equity-based loan has a lower interest rate, it should help you save money in the long run.

Before borrowing against your home equity, use a loan amortization calculator and debt repayment calculator to compare the costs of borrowing against your home versus paying your existing debt, just to make sure it’s worth it. Remember to consider your new loan’s closing costs, too.

Using home equity to invest

Taking out home equity when interest rates are low and using the funds to invest in stocks, ETFs, mutual funds or bonds with higher returns could potentially help you build wealth over time.

But these investments also carry a certain amount of risk, especially if you decide to sell when the market is down. This strategy isn’t for everyone, so be sure to talk to a financial advisor first since you’ll want to make sure that the potential return would be higher than what the loan would cost.

Tapping into home equity for home improvements

You might be able to increase your home’s value by making strategic improvements. Before taking out equity to invest in home upgrades, research how much those projects cost and how much they would affect your home’s resale value. You may find that some projects sound exciting but wouldn’t yield a high enough return or make up for what you’d pay on your new loan.

Using home equity to start a business

Thinking of starting a business? You could look into a business loan, but some companies aren’t eligible for loans backed by the U.S. Small Business Administration, including real estate investment firms, lending firms, and charities or nonprofits.

If you have a considerable amount of equity in your home, though, you may be able to use it to fund your new venture. A word of caution — according to the U.S. Bureau of Labor Statistics, more than 20% of new businesses fail within the first two years. Be sure to weigh your options and research your market carefully as funding your business with home equity could be a risky endeavor.

Taking out home equity for a real estate investment property

If you’re interested in buying a rental property, flipping houses or purchasing a vacation home, you may be able to use your primary home’s equity for the down payment. Investing in real estate can be risky, so make sure you thoroughly research your loan options, the type of property you’d like to buy, and the conditions of the home you’d like to purchase.  

FAQs about using home equity to build wealth

How can I use my home equity to make money?

You may be able to borrow against your home equity to make improvements that boost the value of your home, invest in the stock market, buy a real estate investment property, start a business or to pay off high-interest debt. These strategies aren’t for everyone, though, so make sure to speak with a financial professional and consider how comfortable you are with risk.

What are the downsides of taking equity out of my home?

Taking equity out of your home could help you build wealth in the long run if you use it wisely, but this also comes with risks. Not only do equity-based loans raise your debts and reduce your equity, but they also use your home as collateral, which means you could go into foreclosure if you can’t pay back the loan. You also typically need to pay closing costs, interest and other fees when taking out equity. Crunch the numbers and make sure taking out a new loan makes sense.

What builds the most equity in a home?

Making a down payment of 20% or more when buying a house can help you get a sizable amount of equity from the start. Other ways to build equity over the long term include making your mortgage payments on time and putting extra cash each month toward your principal. Your equity can also rise as your home’s value appreciates over time.

Next steps

Using home equity to build wealth may be a good strategy for some people, but to find out if it makes sense for you, be sure to investigate how much an equity-based loan will cost you in interest and fees. Also, watch out for investment fraud, get-rich-quick schemes and testimonials you can’t verify. If someone is pressuring you to take out home equity to invest in a strategy that sounds too good to be true, it’s likely a scam.

About the author: Jenny Rose Spaudo is a freelance writer and content strategist specializing in finance, technology and real estate. Her writing has appeared in Business Insider, Credit Karma, GOBankingRates and more. Visit jennyroses… Read more.