Recently, we’ve been talking a lot about how homeownership is a very effective tool for wealth accumulation, particularly for low- to moderate-income borrowers. However, not every borrower has a clear understanding of what it means to accumulate wealth through homeownership; they just know that it happens. This article is intended to help you teach them how homeownership contributes to wealth building.
First: Equity. At its simplest, homeowners build wealth by growing the equity in their home. There are several things to unpack here. 1) Equity is the current market value of the home minus however much of the mortgage is left; 2) Borrowers grow equity by making their mortgage payments.
Borrowers might only need the above explanation if they already know a little about homeownership, but first-time homeowners will need an example. Consider using this one: Let’s say that you own a home currently worth $200,000 on the market and that you owe $120,000 on that home; that means you have $80,000 of equity. That number grows a little more with every mortgage payment.
After explaining these items, consider showing the borrower how to keep track of his or her growing equity after becoming a homeowner.
Second: Why Equity? Consider explaining to the borrower that equity is like forced savings; this money automatically goes into the home and is “saved” as the borrower makes mortgage payments. This money is then multiplied as the value of the home increases, which is almost guaranteed to happen over time.
The borrower might have questions about why equity matters if it’s tied into a home and therefore not as accessible as a savings account. You can answer this in several ways:
1. No matter what, housing expenses are going to be an important part of a borrower’s budget. It’s not possible to build wealth through renting as a renter; the money spent disappears, essentially. But money spent on owning a house turns that house into an asset that the borrower owns more of every month (and it’s money that is going to be spent anyway).
2. Houses consistently rise in value over time, and they rise a lot; for example, a house worth $52,000 in 1997 is worth $190,000 today. That’s almost four times the value of the original home. Money left in a bank account doesn’t multiply like that.
3. If necessary, equity can be tapped into through refinances, but explain to the borrower why it’s wise to avoid using equity to pay for frivolous expenses. One way to explain that is to use the above example: equity multiplies a lot over time, but that growth is significantly hindered if equity is tapped into a lot, so equity should only be used to pay for very important things.
Third: Time. The final thing to help borrowers understand about equity is the time factor. Equity can build a lot of wealth, and it’s one of the reasons why homeowners are worth so much more than renters; at the same time, equity doesn’t expand exponentially overnight.
Borrowers should know that this doesn’t mean they need to be committed to thirty years in a single home just to build equity; if they move every few years, but remain a homeowner the entire time, it’s still possible for them to build equity. The goal is to responsibly handle their finances so they can avoid a foreclosure, which will remove all equity, or becoming a renter again, which will also have a negative impact on their equity.
There are, of course, many more things that a borrower will learn about homeownership, but a clear understanding of equity and how it helps the borrower build wealth will help the borrower fully understand why owning a home is so important.
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