If you own a home, you might be sitting on wealth that you didn’t know you had. Dormant home equity is the most common place where people do not accelerate their capital. In fact, the average U.S. homeowner has $153,000 in “tappable” home equity according to a report from the data firm Black Knight—an all-time high. So, in this blog post, you will learn how to use home equity to build wealth.
This real estate strategy changed my friend Mike Davis’ life. I was on his case about becoming a real estate investor for years. He was a pastor who only had $5,000 in his savings—he thought real estate investing was a long way off, if not impossible, for him.
So, I asked Mike how much equity he had in his home, and he told me it would be paid off in two years! I got really excited then. I told him that if he pulled $100,000 of that equity out of his home, he could put a down payment on four properties. A week later, he bought two. Less than ten years later, Mike has multiple doors and is a WealthBuilders Real Estate Coach!
How is Equity in a Home Determined?
First things first. In order to know how to use home equity to build wealth, you need to know how much home equity you have. Home equity simply means that you have cash value built up in your home. As you pay off your mortgage and your property appreciates, that amount will increase.
Here’s how you calculate it:
1. Home Value – Mortgage Balance = Home Equity
So, let’s say your home is worth $390,000. (A quick search on Zillow or Realtor.com will give you a good estimate.) Your remaining mortgage balance is $200,000. That means you have $190,000 worth of equity in your home ($390,000-$200,000=$190,000.)
Now, just because you have that much money doesn’t mean that you get to use it all. You’ll need to subtract 20% of the overall amount of equity you have in your home. The remaining amount is your tappable home equity, or the amount you can withdraw.
2. Home Equity x .80 = Tappable Home Equity
Let’s refer to our example above. If you have $190,000 worth of equity in your home, your tappable home equity would be $152,000 ($190,000 x .80 = $152,000.)
How Home Equity Loans Work
When considering how to use home equity to build wealth, you will most likely opt for a home equity line of credit (HELOC) or a cash-out refinance.
A HELOC is a second mortgage that gives you access to cash determined by the value of your home. It’s a line of credit, so you borrow, repay, and repeat if you’d like.
A Cash-Out Refinance replaces your current mortgage with a larger loan based on your home’s appreciated value. They pay you the difference between the amount borrowed and what you owe on the home.
Cash-out refinances replace your first loan, while a HELOC adds a second loan. In other words, cash-out refinances pay off your existing mortgage and supply you with a new one. A HELOC adds a second payment.
Accelerate Your Capital with Real Estate Leverage
Leverage is using borrowed capital to create a profit. When you put your home’s equity to work, you are leveraging your resources. Now, I’m not an advocate of leveraging all the way up to your eyeballs so that you can’t pay your bills, and you shouldn’t take equity out of your house to purchase things that go down, or depreciate, in value. In other words, don’t use your home’s equity to buy things that most people use consumer debt for. Instead, use your home’s equity to acquire more assets that increase in value. As previously mentioned, you can borrow up to 80-90% in tappable equity as long as you’re able to make the payment and maintain a positive of at least $300 per month.
Another way you can accelerate your capital is to purchase one home a year (with the same $10,000!) Instead of taking $100,000 out when you do your cash out refi, you just take $10,000. Then, buy a $100,000 house and then you do a cash out refi on that property. You get your $10,000 back in 12 months. Then, you repeat the cycle and use that $10,000 to buy another house. You continue to invest the original $10,000 over 10 years, and you acquire 10 homes. [These numbers are just for illustration purposes. It’s almost impossible to find a property for $100,000 in today’s day and age! However, the ratios are still applicable.]
Another example is to utilize $100,000 in home equity. That amount would enable you to buy ten $100,000 homes in one year by placing 10% down ($10,000 on each one.) You now have $1,000,000 in assets in addition to your personal home. In other words, what you control and the ability of your assets to increase has now become tenfold because you aren’t leaving it in one place, but you’re accelerating it.
Just a 5% appreciation increase on these properties is $50,000 in one year. In other words, just the appreciation has made you $50,000 back on the $100,000 you invested!