Episode 64 – Home Equity, How To Build It, How To Access It

Hi everyone and welcome to another wealthy and wise Wednesday, you know maybe if you have been on my video channel, you have seen that I have had this other playlist, if you will, they are called 3 minutes to money mastery and it is just a bunch of short videos that are 3 minutes long, they talk about certain concepts and what they do is they try to keep them under 3 minutes and get a lot of contents out there. I tried to make one or two or three of those each week. But this past week, I did one on equity and I talked about how equity get a zero percent rate or return forever and then I got to thinking you know what? That is a concept that really needs a little bit more understanding and developing, so I thought I would at least start a podcast and video of talking about equity at home.

[00:01:08] so there is a couple, mhen there are two or three different ways to get equity in your home, okay. Now let’s define what equity is? Equity is eventually when it is all said and done, it is the money that you get in your hands if you sold your home. So if you think about your home, you think about what you pay for, you think about what you could sell it for, you think about what your balance is on your mortgage. So let’s just say you bought a house for 200 hundred thousand dollars, it is now worth 250 thousand and maybe you have paid your mortgage down for a number of years and you only owe a 190 thousand. So the equity is the difference between what you owed, a 190 thousand and what you can sell it for 250 thousand. So basically, you have got $60,000 in equity.

[00:02:08] So the question was, what is the rate of return that your equity gets each year and most people try to figure out how much their house grew by that year and then figure out the rate of return and saying oh, well homes in our area went up 4% this year. So my equity must be getting 4% and what I was trying to explain in a very short 3 minutes’ video is that equity actually get a 0% rate of return every day year in and year out forever and ever. It never makes a rate of return and let me kind of show you some of the number and how you can kind of see this for yourself. It is also a good question to ask some of your friends and neighbor and see if they know what kind of return equity gives. Most of them are probably going to figure out how much their home grew that year and assume that is their rate of return on their equity.

[00:03:10] Before I jump into the numbers though, let me ask you or let me talk about the different ways you could get equities in your home. Number one way is to pay down your mortgage. So if I start with a $200,000 mortgage and then I pay that down to a 190, I have essentially created myself $10000 of equity assuming I can still sell the house of $200,000. The other way is for the house to increase in value, so if my house grows from 200,000 to 210,000, I have also created some equity right there. So now, I have got an additional $10,000 in equity due to my house increasing in value. Okay, so those are basically the two ways that you get equity. Another way, which kind of is the start of this whole thing is what your down payment is?

[00:04:16] Okay, so if I come into a $200,000 house and I need to put down 10% or $20,000, I put that 20 in and essentially I have 20,000 in equity again assuming I can turn around and sell the house for the same price that I bought it. But now, let’s look at how equity get a 0% rate of return, we are going to look at two situations. We will first be going to look at somebody who has a 100% mortgage, so they are buying a $200,000 house and they are putting no money down, so they have a $200,000 mortgage. Next year, that house grew in value by 5%, so now it is worth $210,000 or could be sold for $210,000, okay? Now, how much equity did they have in the house when they first bought it. Remember they had a 100% mortgage, so they really had 0 equity to start with. The house grew by $10,000 so now they had $10,000 equity.

[00:05:38] now, let’s take scenario number 2. Scenario number two pays cash, they have $200,000 sit in the bank and they go but a $200,000 house with cash, okay? They have $200,000 in equity, same thing occurs the following years, their house grows in market value from 200,000 to 210,000, okay? They now have 210,000 in equity but here is the key, it didn’t matter if the person was mortgage up to their eyeballs or if the person pay cash, both homes grew 10,000. Equity had nothing to do with it, didn’t matter how much or how little you put in, equity that $10,000 growth was derived from what was going on in the market. So it was the market that created that $10,000 growth or that extra $10,000 in equity. If you really want to look at it from a rate of return perspective, you could say that the guy who paid cash put two hundred thousand dollars down on his home and that 200,000 turn into 210, okay?

[00:07:06] You could then say that the guy who put zero down on his home had a 100% mortgage that he made $10,000 on no money down. So if you want to look at it from that perspective, the guy who did much better well, maybe did much better depends on what his mortgage rate was but his payment was obviously he had money out of pocket throughout that year but he certainly going to have a whole lot less than 200,000 for the guy who paid cash. The point is, the equity made no rate of return, what made the rate of return was the house, it was just the market value of the house, the house grew from 200 to 210 and it had nothing to do with how much it is involved. Okay, so that is kind of a little more thorough understanding of why equity get a zero percent rate of return because equity is only derived two ways, the market goes up in value, your house goes up in value, you get some equity or you pay down your mortgage, you get some equity or like the first guy he dropped in $200,000, he has all that equity but that 200,000 isn’t going anymore for him than the market value of the home.

[00:08:32] You with me, hope that makes sense? And those of you who were driving and listening to this as a podcast, I hope that all kind of came together. So now what we have to look at is how some people utilize their equity. You know you see it often especially in booming economies and we are starting to see it more and more now where people use what is called a home equity line of credit and they basically assess the home equity by going to a bank or some kind of a lender, the lender then put a lean on their home and then they loan money out to the borrower or to the home owner. So if I got $20,000 in equity and maybe I want to buy a new car, I can potentially go to a bank, have them put home equity line of credit on my house, give me $20,000 and then I can go pay cash for the car.

[00:09:41] The downside to that is home equity lines of credit has some sort of repayment. Some of them are just interest only for a while, I remember back in the early, oh it is probably the early 2007, 2006, 2005 where home equity line was huge, in fact, homes were being sold with a first mortgage of 80% and a home equity line of 20%. So you can almost get a 100% where you could, you can get a 100% financing with two different loans on a home. That turned out to be a very risky proposition because as home value fell, now you are upside down, you actually owe more than your house’s worth and a lot of people just walk away from their home because there is no way they could pay them back. A lot of home equity lines also have increasing interest rate, so every year, the payment back to the bank is larger but nevertheless most home equity lines of credit has some sort of repayment.

[00:10:49] Some are just interest only for say like 10 years, so you would just pay interest on that loan for the first 10 years then they would [00:10:57] out to where you are paying both principals and interest maybe for 20 years after that. Something that nature, so home equity lines of credit have a lot of different ways to go about it. The problem again is like I was saying, the home equity line of credit typically requires some sort of a payment. So if I am going to have a mortgage and then I am going to use a home equity line of credit, I am effectively going to have two payments and depending on how that works out, that might take me over the top based on my income and just might be a struggle every year. So be extremely careful with home equity lines of credit.

[00:11:40] Those are called HELOC for short, just in case you hear that time HELOC but from another perspective if you have a ton of equity in your home and a wonderful opportunity comes along and you have access to that capital, you might be able to take that and for instance maybe open up a business. A lot of people use it to remodel their homes, there is a million thing you can do with the home equity line of credit. But just be very careful and don’t just assume because you got equity, you should be assessing and putting it into all kind of different places but if you do have that great opportunities that comes along, it can be a good place to assess some capital.

[00:12:32] Now, one thing that is kind of new this day and this is really interesting is a home equity line of credit, they don’t even call it a HELOC, it goes by a different name but they actually invest into your house, you get your equity but you make no payments and that can be as long as 10 and even as long 30 years before you have to make that repayment and when you make that repayment you do it in a lump sum and most likely you will do it because you are expecting money from another source or maybe you are expecting to sell your house in 10, 20 or 30 years and then you can pay off that investment. But the investment comes in and they will literally loan money against your home equity, give you your equity and you never have to make payments. This could work out really well for some if they are trying to get in a passive investment, maybe some real estate, another income producing asset so that they can produce more income for retirement because a lot of equity sitting there may not be doing that much for them.

[00:13:56] But if they take out a HELOC and then have to make payment, it may not be enough to even be worthwhile. So this new form of equity investing is opening up a whole another opportunity for those who are nearing retirement with tons of equity and they need to create some passive income and now they can get equity out, go get some passive income and not make any payments back and maybe 20, 30 years from now, at their death, they sell the home and then can pay off the investors. Now, of course the investment money is accruing and it can be anywhere from 2-5-6% depending on the amount of equity you have, your credit, all that kind of stuff. Actually that is not even true, it hardly has anything to do with your credit any longer because it is all about the property value and the equity that you have in your home.

[00:14:59] So they are kind of unique, they are certainly, you know they are new enough that I will be very cautious and they are new enough that we probably had to look at what happens over the next few years but I think it is a very interesting concept and again if it only works. Get this again, it only works if you have got a really solid location for that money to go if you were to take that investment loan of your equity but anyway. So that is equity and that is how it works. Now you know that equity gives a zero percent rate of return forever and ever. Now of course, you always have to calculate payments and interests and those kinds of things for the guy who doesn’t have any, who didn’t put any money down on his house then you also.

[00:15:56] So yeah, I got to hit this real quick, so you either going to pay or give up interest right? If I pay off my home 100%, now I am giving up the interest that that money could do for me elsewhere, okay. If I am taking a 100% mortgage, then I am going to be paying interest to somebody. So I am either going to pay it somebody who loans me the money or I might loss interest because I’ve got it all tied up in my sticks and stones and it is not working for me. So those are you know things that you got to really consider as to how much equity you want in your home. And by the way, I got to say this too, I think owning your home is a worthwhile endeavor and if in your heart and then your soul you want to own that home [00:16:48] so you don’t have any payments, no obligations, I think that is awesome and you should do that.

[00:16:54] Always go with your guts, there are somethings that you can put down on paper and pencil and calculate it but still your guts override that. So make sure you consider that as well. But there are some great options out there and I hope this has at least got you stirred up and thinking and how you might handle home equity in your particular case and not every case is the same, so what works for one may not for another. Alright, any questions, shoot them to question@wisemoneytools.com and I will be happy to answer them as quick as I can, if you would like a strategy session, talk about some of these things, see how your situation is going and what you might be able to do to improve let me know as well.

[00:17:42] And finally, don’t forget to subscribe and tell your friends to subscribe and let’s really build a worthwhile channel here and that is about it. Glad you were able to join me today, hope you learn something and I would talk to you next week, take care.

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