As you pay down that mortgage over the 30 year life of the loan, more and more of the property belongs to you.  That means you gain greater and greater equity in your home.  Also as the value of your home goes up due to inflation and normal market appreciation, that value becomes part of your equity as well.  So if you bought a home for $100,000 and you paid off $25,000 as you paid your mortgage each month and the value of the home appreciates to $125,000, you end up with $50,000 worth of increased net worth just by paying your bills each month.

Since most people buy a home to live in for most or all of their lives, the goal is to pay off the mortgage before you retire.  As such, increasing the real equity you own in your own home is a major part of your retirement planning.  There is a lot you can do to strategically use your home equity as part of your financial plan. Let’s talk about a few such strategic maneuvers to use your home equity to its greatest value.

Watching that equity value grow and grow

It makes sense to build equity value by buying a home.  You have to live somewhere so why not build equity rather than pay rent so your landlord can build his equity on your payments?  One way to see your equity take off is to think about where you buy that home.  If you know that a certain area of town will see a lot of growth or that there will be a significant improvement like the addition of a school or recreation facility, buying in that area before the property values skyrocket means easy equity to you.  You get the same home but the value goes through the roof just because of what is going on in the city.  That is smart home buying.

It is good to know what the equity of your home is especially if you are thinking about selling it.  When you sell the home, you “liquidate” the equity which means you turn it into money.  But keep in mind that when you sell your home, about 6% of the value of the sale goes to the real estate broker and that comes out of your equity.  But if your home has doubled in value, that is still a good transaction for you.

There are some situations where selling a home can actually cost you money.  If you did not put any down payment into the purchase of the home, you won’t see any significant equity accumulate as a result of the monthly mortgage payments you make for at least four years.  That means if you need to sell before you even have the 6% real estate broker fees to pay, you will have to come up with that money to pay your broker yourself.  Selling a home is a complicated operation so you will not be able to do it without a broker.  On top of that, if you decided to go with the newest trend in mortgages where you pay the interest on the loan only, you may have zero equity at the time of sale no matter how long you have been paying on it.

There is just one conclusion to draw about handling your mortgage in light of this information.  That is that you need to take charge of your mortgage and pay down the principle as well as the interest if you ever hope to accumulate any real equity value in your home and property.  It is easy to just make your basic payment each month on your mortgage especially when you are just starting out and that house payment itself is a big bill each month.  But if you can structure your budget to make additional payments on the principle each month, you can see the equity part of your loan go up much more quickly.  There have been people actually cut down how long they have to pay on their homes by just making an additional principle payment each month.

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The problem is if you do the math that retirement will get here before you pay off the mortgage.  If you start now paying extra on the principle, it really doesn’t take that much extra each month to “advance” the mortgage significantly.  By knocking 10-20 thousand off of the principle part of the loan over the life of the mortgage, you can see that mortgage come to an end years before the 30 year term and then you can realize that dream of a mortgage free retirement lifestyle.  All it takes is a little planning and some fiscal discipline to keep adding that little extra each month to your house payment.

Look at your program of paying down your mortgage with the same seriousness you would your 401K at work.  If you start when you are young on your 401K, you can accumulate a huge retirement savings to use when you turn 65. Similarly, by starting in the first year of paying on that 30 year mortgage making those extra principle payments, by the time you get to year 20 or 25, that principle will have shrunk in an amazing way.

Some couples really bear down on those extra payments in the years between when they buy the house and the arrival of children.  Since children are a big expense, if you can put a good sized dent in that principle on your home loan, then if you have to drop back a bit to pay for braces and private school, you are still on track to pay your home off in time to retire.  Then when the kids are out of college and paying their own bills, you can then resume your aggressive principle payments to polish that loan off so you own your home free and clear.

You can do the math yourself.  If you buy your home when you are 40 and it’s a 30 year loan, you need to carve about 10 years off of that loan.  Your mortgage company will give you a publication they can make up for you that shows how much of each house payment you make is principle and how much is interest and other fees like insurance and escrow for taxes.  At first, your payments may only apply a few dollars to the principle.  But as the years go by, the amount going to interest goes down and the amount to principle goes up.

An easy way to plan for how much to pay on your principle each month is to not try to work that complicated math that your mortgage company did to create that payment schedule.  Instead, if you need to cut 10 years off of your 30 year loan, you need to pay one third of the principle in 20 years of payments.  On a $90,000 home loan, you have to pay $30,000 by adding additional principle to each month’s house payment.  That seems like a lot of money.  But in reality, by just adding $125 each month to your house payment, you can pay off that $30,000 in just 20 years.  That is real equity that you get to keep so that is just as good as a retirement investment program with a any bank.

There are other steps you can take to increase the level of ownership you have in your home.  If you refinance your home, by dropping the interest rate, more of your payment goes to principle.  You can even set up a shorter mortgage, perhaps 15 or 20 years instead of 30 years.  The payment will be higher but that mortgage will retire about the time you do.  And that is the whole idea.

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Because lenders love to land a HELOC contract, they compete hard for the chance to get your business.  Often the lender will cover the appraisal costs and the fees for title insurance and the like so that you will have little or no costs to bear to set up the loan.  Its worth it to make creditors compete if you want a equity line loan because they will bend over backwards to get that kind of business from you.

Dangers and Sand Traps

That said there are some pitfalls to be on guard about when you are setting up a home equity line of credit loan.  You will see a promotion in which the lender guarantees you will pay no closing costs.  This is a bit of a slight of hand.  What that means is that there is almost always a early termination fee so if you pay off the loan, you pay a hefty cost at the end.  They get their money at the end of the loan rather than at the beginning.

Also be aware of how tempting it will be to only pay the interest on the loan each month.  If you have other high interest credit cards to pay on, you will be prone to not pay on your HELOC loan because it has a lower interest than most credit cards.  Fight this temptation.  You can only “buy back” your equity by paying on the principle each month as well. You should also work to get the principle down so that if a time comes up like the time to buy a car or pay for schooling, you will have some equity there to cover that bit expense.

Finally, put the checks that give you access to your HELOC loan somewhere safe so they don’t become like your regular checkbook.  This line of credit is too critical to use like a regular credit card.  Make it difficult to use your equity so that you only tap the power of your HILOC loan for something important.  In doing so, you avoid “abusing” your second mortgage which will rob you of your equity before you know it.

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