Home equity is a measure of the actual amount of value that you have invested in your home. This measure is not to be confused with the amount of money you have invested in your home, since you will likely pay far more in money than you will enjoy in value…
It may surprise you that unless you have no mortgage or are in the last few years of your mortgage payments, the lien holder (i.e. your bank or lender) will likely have more equity in your home than you do.
This post explains the concept and practical application of equity in a property. Since equity is a big deal when it comes to property investing, this is a topic you should know well in order to be a successful real estate investor.
What is Home Equity?
For the sake of this post, let’s expand the title to be more like real estate equity, since the lessons will apply to any property you buy (commercial, agricultural land, investment income property) even if it is NOT your home.
Lesson 1: Every property has a value and an ownership. When you apply for a mortgage, you allow the lender to take ownership of the property in case you can not pay your financial obligations to them. This is called a lien. If you default on your loan, the lender can repossess the property and now owns it, instead of you owning it.
Lesson 2: As you pay down the amount of money you owe on the loan, you gain equity in the property. This means that more of the property’s worth is actually owned by you, instead of the lienholder. Think of the property as a big pie chart. Each payment takes a really thin slice of pie from the lender and gives it to you, the owner.
Lesson 3: You want to own the property outright, which means that you have no liens left on the home. The more equity you have in the property, the closer this goal becomes.
Property Equity Strategies
Some real estate investors say that you should never pay off your mortgage. Instead, you should leverage equity in your home in order to borrow more money and buy more property. This can certainly be a great way to increase your real estate holdings. Many people have become rich doing this. However there is always the possibility that the entire smoke and mirrors empire you have created will collapse. Sudden changes in the real estate market can make you lose all equity in multiple properties and force you to start paying big bucks to support multiple loans that you really can not afford. Many people have lost everything doing this, as well…
Other investors say that you should do everything possible to pay off loans as soon as possible, including making extra payments, larger down payments or skipping the mortgage process altogether in favor of 100% cash offers. For most people, it is certainly better to live within their means and pay off a loan quicker, increasing equity quicker and actually owning their home outright sooner. This provides more security, albeit at the expense of less investment opportunity in new properties.
Which strategy is best? Well, that depends on you and your goals in life. Some people want to be rich at any cost and are willing to risk it all. Some people simply want to be happy and not stressed by money. They take comfort knowing that they own their home and it can not be taken away from them by some corporate lien holder within a few months of economical downturn.
Home Equity Guidance
I like the idea of actually owning. If I can, I tend to pay off debts quicker, rather than using the debt to make more debt. My pay offs might not be a big, but my liabilities and stress levels are much lower also. I have used a conservative strategy of investing to be able to retire at the age of 39. I believe that either approach can work and a compromise that meets in the middle may also be ideal.
Equity is always a great thing to have, whatever you choose to do with it. Without equity, you are merely a owner in name alone, without any true asset to show for all your work. With equity, you can always decide to leverage it in the future if you so choose, without getting in over your head. One thing is for sure…
Lending institutions make a fortune in interest. You will pay more than the price of the average home in interest alone during the life of your loan. This is like buying the home more than twice… By eliminating the mortgage need, or reducing dramatically and quickly, you will have less cash to invest, but you will have more actual value in your property. In essence, you will actually own it, instead of just pretending to own it. Whichever path you choose, just be sure to do a complete pros and cons analysis of your investment strategy and do what works best for you and your personal objectives.