Want to create wealth through homeownership? Build equity.
Home equity is the percentage of your home’s value that you own, and it’s key to building wealth through home ownership. Let’s take a closer look at how to build home equity without blowing your budget — and how to access it when you need it.
How much equity do you have?
Equity is easy to calculate when you first buy a home because it’s basically your down payment. For example, if you put $11,250 down on a $225,000 home, your down payment is 5 percent and so is your equity.
From 2016 to the first quarter of 2018, most first-time home buyers in the U.S. started with about 7-percent equity, according to Inside Mortgage Finance. This is encouraging because it shows you don’t need to spend years saving for 20 percent down or more before you buy. Repeat home buyers started with more equity, at about 17 percent.
How to build your equity
Here are six ways your home can create wealth for you. Some require time, money — or both. A lender can help you decide what works best for you.
1. Let your home appreciate
Building equity through appreciation can take little time or a lot, depending on the market. With home prices going up like they have in recent years, appreciation has been a boon for many home owners.
Zillow research indicates that the median home value grew from $185,000 in April 2016 to $216,000 in April 2018. If you bought a home for $185,000 in April 2016 with a down payment of $12,950, your beginning 7-percent equity would have grown to 23 percent by April 2018.
We calculate this by subtracting your current loan balance ($165,600) from your home’s current value ($216,000). Then we divide the difference by your home’s current value. One-eighth of this additional 16 percent equity is from paying down your mortgage, and the rest is market appreciation.
If you waited two years and bought the same home in April 2018 with a 20-percent down payment of $43,200, you started off with 20-percent equity. You also used 3.3 times more cash to make the purchase. And here’s the kicker: Your total monthly housing cost would be the same — about $1,050 in both cases.
This example illustrates two things:
First, the power of home appreciation. It’s a lot like buying stock and benefiting as its value goes up. But there’s also a difference: While you’ll pay capital gains on rising stock value, you’re exempt from paying taxes on primary-home capital gains up to $250,000, or $500,000 for married couples.
Second, waiting to “save enough” isn’t the primary factor in determining if you can afford to buy a home. When it comes to qualifying for a loan, lenders do indeed look at your down payment. They’ll also want to know how much you’ll have in cash reserves after closing. But there are lots of options for low down payments that require minimal reserves.
Your monthly budget is the primary factor lenders consider when deciding whether you can afford a home. Lenders will allow you to spend between 43 percent and 49 percent of your income on monthly bills, which is actually on the high side and could strain your budget.
Since 2016, most first-time buyers have spent about 38 percent of their income on housing and other debt, which is a pretty safe cap for budgeting.
2. Make a larger down payment
You can do this but, as we’ve seen, waiting to save extra cash can go against your broader financial interests if you lose the chance to build equity through appreciation. Therefore, you must strike a balance among down payment, monthly budget and savings for other priorities. A good lender can provide rate and market insight to help you do this.
3. Use financial windfalls
Take advantage of work bonuses, family gifts and inheritances to pay down your mortgage. If you do pay down in lump sums, see if your lender will recalculate (or “recast”) your payment based on the new, lower balance.
4. Make biweekly payments
Make mortgage payments every two weeks instead of once a month. Over the course of a year, this will add up to 13 monthly payments instead of 12. You’ll build equity faster and shave five to six years off a 30-year mortgage. Just make sure your lender isn’t charging extra for processing semimonthly payments.
5. Cut your loan term in half
Take out a 15-year mortgage instead of a 30-year mortgage, and you’ll build equity twice as fast. Two caveats here: You’ll have a significantly higher monthly payment and, because of that, you may have a tougher time qualifying.
6. Make home improvements
New appliances or cosmetic features like paint are unlikely to increase value. Only big improvements like new kitchens, or additional bathrooms or other rooms will add meaningful value. Make sure the cost of such improvements will create the added value you’re looking for.
How to use your equity
You must borrow or sell your home to use your equity. The three most well-known ways to get to your equity through borrowing are a home equity line of credit (HELOC), home equity loan or cash-out refinance. Compare the pros and cons of each.
Rates are rising right now, so these borrowing options might cost more in the future. Talk to your lender to determine the best approach for you.
Home equity burning a hole in your pocket? You may want to think twice about that boat.
Home equity is a valued resource, and if you have it, you might be tempted to tap that wealth for other purposes. A home equity loan, which allows you to use your home’s equity as collateral, is a great way to do this. But depending on your personal situation, it may not be the right thing to do.
Here’s when a home equity loan makes sense — and when it doesn’t.
DON’T: Fund a lifestyle
Remember when homeowners yanked cash out of their homes to fund affluent lifestyles they couldn’t really afford? These reckless borrowers, with their boats, fancy cars, lavish vacations and other luxury items, paid the price when the housing bubble burst. Property values plunged, and they lost their homes.
Lesson learned: Don’t squander your equity! Look at a home equity loan as an investment — not as extra cash when making spending decisions.
DO: Make home improvements
The safest use of home equity funds is for home improvements that will add to the home’s value. If you have a one-time project (e.g., a new roof), then a home equity loan might make sense.
If you need money over time to fund ongoing home improvement projects, then a home equity line of credit (HELOC) would make more sense. HELOCs let you pay as you go and usually have a variable rate that’s tied to the prime rate, plus or minus some percentage.
DON’T: Pay for basic expenses or bills
This is a no-brainer, but it’s always worth reiterating: Basic expenses like groceries, clothing, utilities and phone bills should be a part of your household budget.
If your budget doesn’t cover these and you’re thinking of borrowing money to afford them, it’s time to rework your budget and cut some of the excess.
DO: Consolidate debt
Consolidating multiple balances, including your high-interest credit card debts, will make perfect sense when you run the numbers. Who doesn’t want to save potentially thousands of dollars in interest?
Debt consolidation will simplify your life, too, but beware: It only works if you have discipline. If you don’t, you’ll likely run all your balances back up again and end up in even worse shape.
DON’T: Finance college
If you have college-age children, this may seem like a great use of home equity. However, the potential consequences down the road could be significant. And risky.
Remember, tapping into your home equity may mean it takes longer to pay off the loan. It also may delay your retirement or put you even deeper in debt. And as you get older, it will likely be more difficult to earn the money to pay back the loan, so don’t jeopardize your financial security.
The upward trend of our economic status has fueled drastic changes within the housing sector. Inventory shortages have resulted in escalating home values and bidding wars between investors and house hunters. Of particular interest, however, are the changes seen in subsequent rental rates. Several cities throughout the United States have experienced increased rental rates, some of which have doubled in price.
While increased rental rates have burdened tenants, investors of all types have become eager to acquire buy and hold properties. Recent activity has facilitated the development of new projects and made everything from apartment buildings to existing single-family homes a hot commodity. Increased rental rates have even caused some homeowners to move out and rent their property for additional cash yields.
According to MPF Research, San Francisco has experienced the largest surge in rental rates. As such, the Northern California city was placed atop a list with the 50 metropolitan areas that experienced the highest rent growth during the second quarter of this year. San Francisco rents increased by 7.8 percent, according to preliminary estimates by MPF Research market-research firm based in Carrollton, Texas. The following is a comprehensive list of the cities that experienced the highest increase in rental rates:
Increased rental rates have therefore made buying rental properties the latest investment trend. Opportunities for passive income have never presented themselves with such promise. Further supporting the idea of acquiring a rental property are statistics released by Trulia that acknowledged owning a home may be 44 percent cheaper than renting one.
With incentives for owning more promising than ever, now is the time to buy. However, keep an eye on local rental markets while attempting to do so. It is likely not worth the hassle, or price, to have to move from one rental property to another before buying. Increased rental rates may therefore drive many towards ownership. Investors, in particular, are searching for optimal rental properties to take advantage of the increasing rates.
When you decide you want to make the move toward becoming a homeowner, one of the first things you’ll need to do is prepare yourself for the home loan application process. From getting a copy of your credit report and scanning it for errors or inaccuracies, to gathering your proof of income, there are a lot of steps involved when it comes to getting your application ready.
Follow these tips for preparing all essential documents for your loan officer.
Create a checklist
My FICO suggests making a checklist of all necessary paperwork so you can make sure you are completely prepared when you submit your application. Unfortunately, not having everything ready or submitting the wrong document can delay approval.
Reach out to your loan officer and ask for a complete list of all the paperwork needed for a specific loan product. While there might be additional documentation requested, below are some items you’ll need. Remember, these documents are not necessary to apply for a loan:
Gather personal information
In addition to proving you have the finances to support the purchase of a new home, you will also need to provide personal information to your loan officer. Identification topics include your social security number, legal status and two forms of government identification.
“Reach out to your loan officer and ask for a complete list of all the paperwork needed.”
Come in prepared
Realtor.com indicated that you will want to be able to demonstrate your financial competence and ability to manage a mortgage loan responsibly. Bring along information about whatever home you are interested in purchasing. Have a folder with everything you need as soon as you head in to speak with your loan officer.
Know who can get your paperwork
Some of the necessary paperwork can easily be retrieved. However, information about the listing you are interested in will likely need to be gathered from the real estate agent or property manager. This is why you should enlist the help of a professional who has the experience and knowledge to understand what you need and where to retrieve it.
Invest in storage now
The earlier you get a filing cabinet or other type of organization system, the better off you will be when you decide to apply for a home mortgage. When you have everything in one spot and collect essential documents, the application process will be smooth and efficient.
Becoming more informed and organized will ensure your journey toward homeownership is pleasant and exciting. In addition, having all your documents ready to go minimizes the chances of denial.
Prominent tax advisers still don’t agree on whether all those people who prepaid 2018 property taxes can deduct them in full.
The debate on such deductions arose after Congress passed the largest tax overhaul in three decades late last year. In a landmark change, lawmakers capped write-offs for state and local taxes at $10,000 per return for both single filers and married couples. The provision takes effect for 2018 and will lower these write-offs for millions of Americans.
The overhaul barred deductions for many prepayments of 2018 state and local income taxes, but it was silent on deductions of prepaid property taxes. After Christmas, long lines of people rushing to prepay their 2018 property taxes before year-end gathered at local government office.
Then on Dec. 27, the Internal Revenue Service warned that not all prepayments of 2018 property taxes would be deductible on 2017 returns. The agency said that to qualify for a write-off, the tax liability actually had to have been known at the time.
Right away, some tax specialists strongly agreed with the IRS but others strongly disagreed. The IRS and its supporters argued that those who prepaid all their 2018 property taxes can only deduct the portion that was known or determined at the time. In many cases, that means only for a few months of the year or not at all.
The IRS’s opponents argued for higher deductions of reasonable estimates. They based this argument on prior tax rulings and regulations that they think apply to this issue.
Now, three months later, little progress has been made.
Leading the opposition against the IRS’s position is Lawrence Axelrod, an attorney at Ivins, Phillips & Barker.
“The IRS position is misguided because it doesn’t take into account Treasury’s own regulations,” he said.
These regulations allow taxpayers to deduct amounts paid that will be due within 12 months. The IRS and its supporters disagree. They cite court decisions which say that to be deductible, taxes must have been imposed and the amount must be known.
Stephen Baxley, who heads tax planning for Bessemer Trust, a prominent multifamily office, agrees with Mr. Axelrod.
“If the amount is a reasonable estimate made in good faith, it’s deductible,” he says. The firm is responsible for preparing nearly 1,000 individual returns.
Other tax preparers agree with the IRS.
Brian Lovett, a certified public accountant with WithumSmith+Brown in New Jersey, where property taxes tend to be high, says his firm is following the IRS’s guidance: “We think the amount due must be determined for a prepayment to be deductible.”
The correct answer matters.
More than 80% of property-tax revenue is collected by local governments with a fiscal year other than Dec. 31, according to the latest data compiled by the Lincoln Institute of Land Policy. Frequently, the fiscal year ends on June 30.
As a result, total property tax bills for 2018 weren’t determined by year-end in many areas of the country. Many could reasonably be estimated, however.
For example, say John lives in a county with a fiscal year ending June 30. By the end of 2017, he knew he would owe $6,500 in property tax due by June 30, 2018. He could likely assume that his bill for the second half of 2018 would be about the same. So in late December, he prepaid $13,000 for 2018 to his county.
According to the IRS’s position, John can only deduct a prepayment of $6,500—because the amount due for the second half of the year hadn’t been set.
But if Jane lives elsewhere and knew she would actually owe $13,000 in property tax for 2018, she can deduct a prepayment of that amount on her 2017 return.
Some advisers allow both approaches. David Lifson, a CPA with Crowe Horwath who has many high-earning clients, says he recommends that clients deduct prepayments of known amounts. But he will allow a deduction of an estimate, “if I feel the client understands the risk that the IRS will disagree.”
The debate is ongoing. In March, Democrats on the Ways & Means Committee wrote acting IRS Commissioner David Kautter to protest the IRS’s interpretation of the law.
The good news for taxpayers who want to deduct prepayments of estimates is that neither Mr. Lifson nor Mr. Baxley thinks these write-offs need to be disclosed on IRS Form 8275. On it, taxpayers are supposed to disclose risky positions to avoid certain penalties. Supporters of the IRS’s position think the form should be filed, however.
Some taxpayers are also pushing preparers to take the deduction because the audit risk is low, given constraints on IRS resources.
Emily Matthews, a CPA with Edelstein & Co. in Boston, says she explains the IRS’s position to clients. But she says, “I think we’ll see a lot of people who prepaid estimated taxes opt to deduct them.”
Real Estate Investing Basics Tip #1 – The Best Investors Understand Marketing
Marketing is the first area of the business you should study as a beginning real estate investor. Marketing is what makes the phone ring and generates leads. Leads are the lifeblood of your business. They are the oxygen your business breaths. The more leads you have the more money you will make. If you don’t have leads, then you won’t buy any properties. If you don’t buy any properties then you can’t make any money. If you can’t make any money then you can’t build a business. As a result you should spend the majority of your time figuring out how to get your phone to ring with motivated sellers. (The same thing can be said for dating!)
Successful marketing is an art, and those who understand marketing set themselves apart from other investors. There must be a mindset shift as an investor. You are not in the business of flipping homes. You are in the business of generating leads from people who want to sell their home under market value. If you can do this you will control the market and you will figure out the rest of the business very quickly. If you have a potential $80,000.00 dollar pay day on the other end of the phone believe me you learn quickly.
There are many different forms of marketing you can utilize to get your phone ringing. Direct mail, billboards, TV, cold calling, and networking are all marketing strategies you can use to find deals. The key is to narrow down your market and find your target, develop a compelling message with an irresistible offer, and consistently touch these people with multiple marketing mediums. Then you will want to develop marketing systems so you can repeat this process over and over again.
Real Estate Investing Basics Tip #2 – Wholesale Properties to Build Your Cash Cushion
Once you find the deal now you have to find someone who is willing to buy the deal from you at a higher price. This is where wholesaling comes into play. Wholesaling is the business of finding bargains and selling the deals to bargain hunters at a higher price. You are not adding value to the property. Wholesaling properties should be essential part of every real estate investors business. It is a way to generate income with little to no risk. Many times, you never take ownership of the property – you simply are the transaction coordinator. In essence, you are bringing a buyer and a seller together. Through your marketing efforts, you locate deals and then you assign them to other investors that you locate through your various forms of marketing. If your marketing machine is in motion, you should have no problem finding buyers. Successful marketing and networking in the real estate community will enable you to find wholesale buyers.
Real Estate Investing Basics Tip #3 – Rehabbing for Large Profits
Rehabbing is when you redevelop the property yourself instead of wholesaling the property to someone else. This is where the larger profits lie. The reason is you will be selling the property to a retail buyer who will be willing to pay full market value for the property as opposed to a another investor who is looking for a discount.
Rehabbing is an entire business in itself and there is a lot you need to learn about this niche. It is important if you choose to include rehabbing in your business that you spend time educating yourself first. Learning pricing of labor and materials as well as whom are the qualified contractors in your area is essential to rehabbing properties.
Being able to add value to properties through renovations is a not only very profitable, but also very rewarding. You are providing a great service, not only to the city in which you do business, but also to the end buyer of your newly remodeled home. When you become experienced at rehabbing you will have the confidence to be able to take on projects that many people would never even consider. This separates you from the other investors and creates more opportunities for you in that real estate market.