If you've ever thought about buying a home, you've heard the song and dance on home equity plenty of times. You know that home equity can help your credit score. It can be leveraged for borrowing. It is forced savings and will boost your personal net worth. Most importantly, you know that in getting a mortgage, you pay yourself back with every payment.
While home ownership is a good financial decision for many families, the benefits of home equity are frequently overrated by homeownership proponents.
The Housing Market Has Risks
For generations, home equity has been the holy grail of wealth accumulation for families. In 2007, the median family held nearly $100,000 in home equity, according to the Fed's Survey of Consumer Finances. Home equity was responsible for nearly three quarters of family wealth. However, that's all in the past.
By 2010, the Great Recession ravaged median family wealth. Most families took their losses from only one of the many assets commonly held: home equity. Home equity plunged nearly 40 percent and was responsible for creating the lowest levels of middle class wealth in the last 10 years.
For decades, Americans assumed that home prices were a safe investment for their wealth, but the recent recession has disproven this assumption.
Home Equity is Just a Number on a Piece of Paper
There are two ways you can get value for your home equity. You can sell your home or you can leverage your equity for a loan. In both cases, the amount of money you get converting equity to cash is much less than the number you calculate on a piece of paper.
Selling your home comes with a number of selling costs. Usually you pay 6 percent commission to the realtors you use, plus legal fees and potential selling concessions. Unless you are a realtor and real estate lawyer, you probably can't get 100 percent of the equity in your home by selling.
Borrowing against your equity often comes with bank fees and will certainly carry interest costs. If you were to utilize a reverse mortgage, banks usually only let you borrow up to 80 percent of your equity's value.
Home equity looks nice when you subtract the selling price of your home from the principal you owe on your mortgage, but the real value of the equity is far less.
Converting Home Equity to Cash Takes Time
Let's say you want to sell your home and cash in on the equity. Realistically, cashing in on equity takes time, and that means lots of hidden costs. If you were to move out before selling your home, you'd be losing money with every property tax payment. Even if you plan on staying in your home until a sale is made and then moving into an apartment, there are issues of moving and storage costs. Getting value for your equity is rarely hassle-free.
Home Equity Requires Maintenance
Home equity is nothing like a nugget of gold. You can't simply buy a home, lock it away in a safe, and expect the house to look unchanged 30 years later. If you want your equity to hold value, you'll need to update old fixtures and repair your home when things wear out or break. Many homeowners let their curb appeal slide or allow their interior to become outdated. Sellers are later shocked when prospective buyers are able to bid far lower than homeowners expect.
Your Equity is Sensitive to the Poor Behavior of Your Neighbors
Is your neighbor's house falling apart? How many homes on your street are in foreclosure? None of these questions may seem related to you, but they are related to the value of your home. A poorly maintained neighborhood is an eyesore for prospective buyers, and too many houses in foreclosure floods your local housing market. No matter how beautiful your house might be, the bad behavior of your neighbors will hurt the value of your equity.
Just because home equity is overrated doesn't mean that home ownership is a bad idea. Current interest rates make buying a home cheaper than ever. When you take out a fixed-rate mortgage, part of your housing costs are fixed for as long as you own the home. At the same time, you get to dodge rent inflation.
These are attractive benefits that don't change with the winds of financial turmoil, the passage of time, or the foolishness of others. Don't get caught up with the mantra of home equity.
JP is the author of the money blog My Family Finances, a site dedicated to helping families make wise financial decisions. He is also an MBA and works in corporate finance.
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