Finance

How to Use Home Equity to Build Wealth: 5 Ways

August 30, 2023

Find your ideal home, take out a mortgage, and eventually you or your children make a profit when the house is sold. Is this the only formula for building wealth from home equity?

Not necessarily. Homeowners don’t often realize that home equity can be used to grow wealth in other ways.

Equity isn’t just a golden egg to sit on over decades. It can actually be leveraged for investments, higher-earnings education, and business opportunities that help you grow your family’s financial portfolio. Stay tuned while we discuss how to use home equity to build wealth.

What Is Home Equity?

The most straightforward home equity definition is how much of the property you own at a given time, calculated by subtracting what’s left on your mortgage from the current market value of your home.

The current market value of your home isn’t tied to what you originally paid for your real estate property. Rather, it’s what someone would pay for it now, predicted by recent sales of similar homes and established by a professional appraiser (or estimated by an online home valuation calculator).

How does building home equity work? Let’s say over the past months and years, you’ve made monthly payments on your mortgage loan. Every time you pay down the home loan principal, it tips the balance of who owns the house, like water from one bucket to another—a little more to you, a little less to the lender.

At the same time, your real estate property tends to grow in equity organically over time with each monthly payment and increases with any improvements you make to it. If you’re wondering how to build equity in a home faster, extra payments a month, like a biweekly mortgage payment, can be one way.

How to Access Your Home Equity

There are alternative ways to get equity out of your home, but How exactly do you turn equity into usable cash? You can’t exactly shell it out at a check-out counter to pay for your groceries. Instead, you’ll usually borrow against a portion of it through a:

Home equity loan
Home equity line of credit
Cash-back refinance
Sale-leaseback program

A sale-leaseback program (SLB) is a debt-free option to make your equity (all of it) work for you without leaving your home. It combines a property sale with a lease and guaranteed right of residency as a renter for as long as you choose.

How to Use Home Equity to Build Wealth

Building equity has many benefits in terms of increasing wealth. Once you have cash in hand, what can you do with it? The saying “it takes money to make money” is true in this case. Here are five options to multiply your home equity dollars.

#1 Pay Off High-Interest Debt

If you’re curious about how to use home equity to your advantage, one way is to pay off debt. Paying off high-interest debt is a cornerstone to wealth building, as integral as setting up an emergency savings fund and a budget. It may seem like digging the hole deeper to take out a new loan in order to pay for older debt, but it’s a good choice if you’re struggling to pay off high-interest credit cards or personal loans.

#2 Rent and Manage Property

Ready to become a property manager? If you’re handy around the house, you might want a hands-on role; otherwise, use a rental property management firm to operate solely as an investor.

The national average rate of return on residential rental property over the last two decades is 10.6%, but how much you earn will depend on many factors, including:¹

Rental occupancy rate in the area
How current mortgage interest rates and home prices affect potential first-time buyers
Condition of your property
Turnover

#3 Start a Side Business

A passive income, consulting, or part-time business based on your resources and talents can help increase your wealth and range of opportunities. In addition to generating income, you’ll benefit from tax breaks that come with running a sole proprietorship or single-party LLC.

#4 Pay for Money-Making Education

Building equity can be beneficial when it comes to educational purposes rather than taking out a student loan, for example. Education is a common use of home equity loan proceeds, but for the purpose of growing your wealth, you can choose an educational path that opens more lucrative career doors.

For example, you might shop around for an affordable master’s program online that allows you to study from home and jump the career ladder more quickly.

#5 Investments

Want to make your equity work for you? Get out your calculator and double-check your math before you take out an interest-bearing loan and put your money into stocks, bonds, mutual funds, or exchange-traded funds (EFTs). You’ll want to determine:

The return you’ll get on your investment
The cost of borrowing money
Your ability to tolerate risk

For instance, if you take out a home equity loan at the 8.47% average rate (as of July 19, 2023), and invest the money in stocks that yield the 12% average return, then you’ll have made money.^2,3

Key Takeaways

There are multiple ways to borrow against your equity or sell it in order to free up cash. One option that enables you to convert the entirety of your equity is a sale-leaseback program that enables you to continue living in your home as long as you’d like.

You can apply the cash derived from home equity to investments that generate a higher return rate than your loan interest rate, start a business, pursue education to increase your earnings, or buy a rental property. First, however, consider paying down any high-interest debt. All of these methods can contribute to your income or financial portfolio.

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