The decision to buy your first home can be difficult. While renting can feel safe and comfortable, it means sacrificing the benefits that come with home ownership. One of the biggest perks to moving from renting to owning is the opportunity to build home equity. The equity you hold in your home can become your biggest financial asset and it can steadily increase over time.
Here's why home equity can be a life-changer.
Your Money Benefits You
When you buy a home, you are investing in your own future – not someone else's. Unfortunately, the latter is exactly what you are doing when you pay rent; providing your landlord with passive income and funds for their retirement.
When you buy your own home, portions of your monthly payments go toward your mortgage balance to build equity. Over time, the principal portion of your mortgage payments goes up while the interest portion reduces. The longer you stay in your home, the faster you will build equity that you can unlock in many ways for your own benefit.
Finance a New Home Purchase
Many people won't stay in the same home forever. The equity you build in your first home – which will likely include your initial down payment – can be used to help you buy your next home.
When you leave an apartment you are renting, you leave with nothing but your belongings and savings. When you sell your home one day, all of the proceeds after paying off your mortgage are yours. You may walk away with a sizeable amount of money that can help you buy a home that matches your new needs and goals. Some people use their equity to buy a home that is larger, closer to the city, or in a better school district.
Borrow Against Your Equity
You don't need to sell your home to access your equity. There are a few ways to borrow against your home equity without leaving your house. Each option comes with its own advantages and drawbacks, but all can be used to do anything from financing home renovations or a big purchase to consolidating debt or even buying a second property.
The most common option is a home equity line of credit (HELOC), which gives you a credit line of 65% to 80% of your home's appraised value, minus your unpaid mortgage balance. This type of loan typically has a variable interest rate but you can access your credit limit as needed. This means you can use your HELOC much like an emergency fund, just in case you need the money, or you can draw on your credit line as needed during home improvements.
Another option is a second mortgage, which gives you a lump sum of money deposited directly in your bank account. Some lenders even allow you to borrow against any amount you have prepaid on your loan as a lump sum.
Fund Your Retirement
It's never too soon to begin planning for retirement. The home equity you begin building today can help you live in comfort when you're ready to stop working.
There are a few ways in which your equity can pay off in retirement. You may one day choose to downsize to a smaller home or condo with lower expenses, in which case the equity you have built may be enough to buy a home outright or dramatically reduce your housing expenses.
A reverse mortgage can be another option. This type of mortgage allows you to borrow up to 55% of your home's value if you are at least 55 years old. A reverse mortgage allows older homeowners to stay in their home while converting some of their equity to cash as regular payments or a lump sum.
Here are some other ways your home equity can become a major source of income when you retire.
Negotiating Power on Your Mortgage
At some point, your mortgage term will be up for renewal. The equity you build in your home can serve as leverage to negotiate a better mortgage rate or conditions on a loan with your current lender or a competitor.
Building equity is all about thinking about the future – your future. Buying a home means you aren't just paying for housing; every month you're contributing money that you can use in the future to improve your life in very real ways, whether it's buying a new home, funding your retirement, negotiating a better loan, or even transforming your home to meet your ever-changing needs.