One of the biggest assets you will ever own is your home. The debate on whether a home is an investment will never die, but there is no question that the ideal situation for a homeowner is to build equity.
Get Rich Quick Scheme: Home Value Increase
Not so long ago, people purchased homes to see the value of the home rise. If you purchase a home for $200,000 with a loan for $160,000, you have $40,000 in home equity. If the value of the home quickly rises to $250,000, all of a sudden you have $90,000 in home equity.
This logic was a major contributing factor to the major housing bubble that the United States economy is still recovering from. So many people were buying homes so quickly that housing prices escalated beyond their intrinsic value. This led to a bubble burst where homes lost value.
If you are buying a home, resale value is an important factor. Only buy homes in a neighborhood that you believe will hold its value. If home prices stay the same or rise in today’s conditions, you are a winner.
Tried and True: Pay Your Mortgage
The less glamorous way to build home equity is to buy a home and make mortgage payments. If you buy the same home above and your house value remains the same, the only way to build equity is to pay off the loan. If you make a $10,000 principle payment (of pay that much over time), your equity increases to $50,000. That is not as sexy as getting $50,000 for nothing, but it can make a big difference in your life.
Making bi-weekly payments will also help you pay down your loan quicker. This is because you are paying less interest and you are making two extra bi-weekly payments every year. Use this as part of a debt snowball strategy to save a lot of money on interest over time.
The Benefit of Equity
Aside from the value in your net worth calculation, what is the big benefit of equity? Unless you take out a home equity loan, you can’t spend it. So what is it good for?
Today I can comfortably afford a house worth about $220,000. That will get me a moderate sized house in the neighborhood I want to live in. Nothing fancy, but it does the trick. Someday I want something fancy. To get there, I need to build home equity. When I sell my first house in the future, I can use that cash as a down payment on the next house. Assuming my equity goes up, I can buy a nicer house than the one I sell.
At the end of the day, while a house is worth money, it is worth a lot more than that. Its true utility is the shelter it provides you, the place for your family to live, the venue for your next party, the meeting place for your friends, the place you relax, the place you have a BBQ, and the place you call home.
Photo by Casey Serin.