Rob Pellegrini

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It is often said that homeownership builds wealth. So, what is home equity, and how can it enhance your net worth?

What is home equity?

Building home equity is a bit like investing in a long-term instrument, like bonds. Your money is, for the most part, locked up and not spendable. There are some ways to tap it, but wealth is created over years as your share of “free and clear” ownership of the house increases.

Home equity, by definition, is the current market value of your home, minus what you owe. You’re looking for a positive number there. Any gain comes from:

  1. Paying down the principal on your loan
  2. An increase in market value over time

It seems simple enough, but it’s not guaranteed. Just ask any homeowner who went through the most recent housing bust. When a housing bubble bursts, home equity can be an elusive concept, especially in underperforming housing markets, or if considered over the short term.

As a rule, building home equity is a slow climb, at best. U.S. residential year-over-year home price appreciation averaged just 1.89% over the last 20 years, adjusted for inflation, according to CoreLogic, the Bureau of Labor Statistics, and the Urban Institute.

However, behind that average are some major year-over-year price swings during the same period, ranging from +12.6% to -18.1%, according to the Urban Institute. When it comes to short-term home appreciation, sometimes it’s more of a bungee jump than a climb. It’s a good thing your home’s value isn’t texted to you monthly.

Why is home equity important?

The gradually expanding value of a home is a financial resource that can gain momentum over time. Because mortgage payments reduce the debt as the asset itself gains worth, paying on a house has been called “a forced savings account.” This is unlike virtually every other type of asset purchased with a loan, such as vehicles, which lose value while you pay them off.

A growing number of U.S. homeowners are amassing “impressive stockpiles” of home equity wealth, according to Daren Blomquist, senior vice president at ATTOM Data Solutions, in a recently released study.

At the end of the second quarter of 2017, there were more than 14 million American properties considered “equity rich” — meaning the debt on the property was 50% or less of the home’s current market value.

That’s about 24% of all owner-occupied homes with a mortgage.

Home equity takes time to build

Another nutrient helping to grow home equity wealth is time. Homeowners who stay in their homes longer are more likely to accrue equity.

In the second quarter of 2017, people selling their homes had lived there an average of more than eight years. That was the longest ownership period since ATTOM began tracking homeownership tenure in 2000. Before the recession, people were staying in their homes an average of about four and a quarter years, ATTOM data show.

“That’s a paradigm shift — a more conservative approach to homeownership and building wealth through homeownership,” Blomquist tells NerdWallet.

The study found that over 45% of properties owned for more than 20 years were equity rich. However, that number seems remarkably low, considering the long period of ownership.

“Keep in mind these are the subset of owners who still have an outstanding mortgage,” Blomquist says. “Our data shows 40% of all homeowners who have owned more than 20 years own their properties free and clear, compared to 34% of all homeowners.”

Blomquist says it is also a testament to just how widespread the ripple effects from the housing crash of the last decade have been.

“Many of these homeowners of 20-plus years lost huge amounts of equity during the downturn as home values plummeted 30% nationwide and much more in some markets — a deep hole to dig out of even with the strong market recovery of the last five years,” he says.

Just 10% of homes owned for less than one year are considered equity rich, according to ATTOM.

How does a home equity loan work?

You don’t have to sell to tap the profit inside your home. Instead, you can borrow against that value with a home equity loan or line of credit. A loan will provide you a lump sum; a HELOC allows you to draw on the available balance as you wish.

While the establishment of home equity lines of credit is increasing — in fact, they’re at an eight-year high — there are now one-third fewer HELOC accounts than during the prior housing market peak, in 2005.

Blomquist believes there is a new, cautious attitude to tapping home equity among today’s homeowners. And such a conservative approach is yet one more important component to building wealth.

» MORE: The pros and cons of home equity lines of credit

Home equity is not a get-rich-quick scheme

Building home equity is definitely a long-term proposition. Blomquist says wise words from one of his relatives may state it best.

“My wife’s great-grandfather — who bought property in Southern California a long time ago — his advice was, ‘You take care of a piece of real estate for 20 years, it’ll take care of you forever.’”


The article Home Equity Explained: What It Is and Why It Matters originally appeared on NerdWallet.

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We all make New Year’s resolutions, but let’s be honest, most are wishful thinking. By February, that “lose 20 pounds” or “learn Spanish” resolution has gone right out the window.

But not for you, new homeowner. This year is different.

Your first 12 months of homeownership set the tone for the entire journey. With just a few smart decisions, you can save money now and get more out of your investment later.

So make room on that list between “run a 5K” and “travel more.” Here are essential New Year’s resolutions for new homeowners.

1. Start an emergency fund

Homeownership has a funny way of costing more than you think. An emergency savings fund provides a financial safety net, and your new home is the perfect reason to start one.

Remember, if the furnace quits on a cold night, there’s no landlord to call. Laid off unexpectedly or surprised by major car repairs? Mortgage payments are still expected on time and in full. Without an emergency fund, these expenses could force you into credit card debt or worse.

Ideally, your emergency fund should cover several months of expenses, but it’s OK to start small. Set aside a portion of every paycheck with the goal of saving $500 as quickly as possible, and then contribute as much as you can moving forward.

2. Take a closer look at your homeowners insurance

Just because a standard homeowners insurance policy satisfied your lender, it doesn’t mean you’re adequately covered.

“Homeowners insurance isn’t one-size-fits-all. There are unique coverage options and, more importantly, ‘exclusions’ that homeowners need to be aware of,” says Ryan Andrew, president of The Andrew Agency, an independent insurance agency in Richmond, Virginia.

Does your policy cover the full cost of your jewelry or other valuables? Are disasters like earthquakes and floods excluded? Will the policy pay if your dog bites the new mailman?

“Your home is usually your biggest asset,” Andrew says. “Spend a few minutes reviewing your coverage and exclusions, and ask questions so you understand your policy.”

» MORE: Choose the right amount of homeowners insurance

3. Get an energy efficiency audit

Heating, cooling and powering a home isn’t cheap. Why be uncomfortable or spend more because your house wastes energy?

After the dust settles, you may notice more about your home, particularly if you bought new construction, says Jessie Ferguson, director of operations at Renewablue, a home energy consulting company. Maybe the air smells funny or one bedroom is colder than the others. She recommends getting an energy-efficiency audit rather than guessing at the problem.

Using blower door tests and infrared cameras, energy audits measure air leaks and detect air infiltration or missing insulation. Audits are performed by utility companies, city governments and some contractors.

“An energy audit is an inexpensive way to get real information about your house. They’ll tell you which fixes will deliver the best bang for your buck,” Ferguson says.

In addition to lowering your utility bills and making you more comfortable, a more efficient home may end up putting free money in your pocket, thanks to local, state and federal rebates.

4. Consider a home warranty

If the appliances in your new home are near the end of their life cycles, a home warranty may help shield you from the cost of replacement.

Also called home service contracts, home warranties are annual agreements that offset the repair or replacement cost of major home components and appliances.

Approach home warranty companies with caution, however. Read customer reviews and avoid gimmicks that seem too good to be true. Like insurance policies, home warranties are full of fine print, and homeowners often fail to realize what’s excluded until they try to make a claim.

“They can be helpful in the first year of homeownership, when you have so many other things to think about and pay for,” Ferguson says of home warranties. “Just make sure you know exactly what you’re getting.”

» MORE: Are home warranties worth the cost?

5. Create a disaster kit with a home inventory

Your new home is your castle, but it’s not indestructible. A disaster kit that includes financial documents and a home inventory will speed up recovery if the unthinkable happens.

A home inventory can be as simple as snapping pictures of big-ticket items in your home, or you could record items, brands, original prices, ages and condition in a spreadsheet.

No matter which method you choose, a home inventory is the best way to make sure you have enough insurance coverage to replace your valuables, Andrew says.

Store the inventory, along with copies of your personal identification, credit card information, vehicle records and other important documents, in a fireproof safe or another place that’s easily accessible if you have to evacuate.

6. Make a plan to build equity

Unless you bought your home with cash, it will be many years until you own it outright. Make plans now to build equity faster so you can unlock more benefits of homeownership even sooner.

Equity is a fancy word for ‘how much of your house is paid off.’ Home equity is a valuable asset; accrue enough and you can use it to finance major renovations or pay off student loans.

You can build equity slowly just by making your monthly mortgage payments, or you can find ways to speed up the process. For example, take on smart home improvements or switch to biweekly payments to get “equity rich” even faster.


 
 

The article 6 For-Keeps New Year’s Resolutions for New Homeowners originally appeared on NerdWallet.

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A home purchase brings together so many things under one roof: dreams, shelter, status, maybe a passport to better schools and neighborhoods. And one more thing: It gives you a forced savings account.

It does that by letting you build home equity, which is the difference between your home’s market value and what you owe on it. Your equity increases with each house payment you make. When home prices rise, your equity grows faster as your home’s value increases.

Stockpiling home equity gives many savers an exceptional feeling of satisfaction. Those forced savings also are a mighty resource to tap if you’re hit with an unexpected expense or want a boost on one of life’s milestones, like helping a kid through college or upgrading the home.

For these big life expenses, you can draw on your equity with a home equity loan or line of credit. The secret is moderation. Remember, building equity is often worthwhile, but you need to keep your financial life in balance by responsibly paying off debt, saving for retirement and being ready for emergencies.

To step on the gas and speed up the growth of equity, you’ve got two main tools: You can increase the home’s value or reduce the mortgage debt. Or both.

Here are six tips to help you build home equity:

1. Make a big, fat down payment

Get equity from the start with a larger down payment, since that is instant equity. Put down 20% or more of the property’s value for a bonus: You’ll avoid pricey private mortgage insurance.

2. Get a 15-year mortgage

Talk about forced savings. Taking out a 15-year mortgage, or refinancing into one from a 30-year loan, piles on the equity — and at a lower interest rate. You’ll save plenty on the total interest, too, because you pay interest for less time. But remember, there’s a catch: Your monthly payments are higher with a 15-year home loan.

“Homeowners should concentrate on reducing their mortgage in order to gain equity,” says Roslyn Lash, a real-estate broker whose company, Youth$mart Financial Education Services, aims to educate teens and millennials. Refinancing into a 15-year loan can be “a great way to build equity because a lower rate means that more money is applied to the principal,” says Lash, who also is an accredited financial counselor.

3. Improve the property

Some remodeling and improvement projects boost a home’s equity. But not all do. The average payback on common upgrades is 64 cents for each dollar spent, according to Remodeling magazine’s research. And that’s if the home sells within a year. Smaller projects — adding attic insulation, replacing a garage door or front entry door — do better at increasing equity, especially if you pay with cash instead of via a loan.

4. Pay more on your mortgage

Paying more can be a good option. If you decide to do this, make sure the extra money is applied to your mortgage principal. Ask your mortgage servicer (you can find the phone number on your monthly statement) how to do it and watch your monthly statements to be sure the money is credited correctly. Here are a few ways to pay more regularly:

• Add an extra sum to your monthly payment. Pick an amount big enough to make a difference but not so big that it crimps your budget. For example, if your payment is $983, round up to $1,100, and then increase the amount when you’re able.
• Another version of adding to your monthly payment: Boost the payment by an amount equal to a twelfth of a payment. By the year’s end, you’ll have made an extra payment.
• Switch to biweekly mortgage payments. Paying every two weeks instead of monthly adds one extra monthly payment to your mortgage annually.
• Schedule extra payments automatically from your bank to your mortgage account at regular intervals

5. Use gifts, bonuses and windfalls

If you don’t want the commitment that comes with a 15-year mortgage or increasing the size of your payment, look for cash that dribbles in here and there. Holiday and birthday gift cards? Convert them to cash and add it to your mortgage. Dedicate overtime pay, bonuses or every other bonus to building equity. Cash gifts? Ditto.

If you are fortunate enough to inherit money, use at least part of it to pay down the mortgage. Your mortgage servicer can tell you how to add dribs and drabs or a big windfall to your equity. As before, make certain the money goes toward the principal, not interest.

6. Earmark one partner’s salary

Couples who want to bump up equity in a hurry sometimes take the route of living on one salary while committing the other person’s paychecks to paying down the mortgage.

The belt-tightening can be demanding but the rewards can be extreme.


The article 6 Ways to Build Your Home Equity (and Savings) Faster originally appeared on NerdWallet.

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