Wealth and Equity

Over the many years that you are likely to own it, your home should become an important part of your financial net worth -- that is, the difference between your assets (financial things of value that you own such as bank accounts, retirement accounts, stocks, bonds, mutual funds, and so on) and your liabilities (debts). Why? Because homes generally increase in value over the decades while you're paying down your loan (mortgage debt) used to buy the home.

Even if you're one of those rare people who owns a home but doesn't see much appreciation (increase in the home's value) over the decades of your adult ownership, you will benefit from the monthly forced savings that results from paying down the remaining balance due on your mortgage. Retirees will tell you that one financial joy of retirement is owning a home free and clear of a mortgage.

All that home equity (which is the difference between the market value of a home and the outstanding loan on the home) can help your personal and financial situation in a number of ways. If, like most people, you hope to someday retire, but (also like most people) saving doesn't come easily, your home's equity can help supplement your other sources of retirement income.

Tapping into equity

How can you tap into your home's equity?

• Some people choose to trade down -- that is, to move to a less costly home in retirement. Sell your home for $250,000, replace it with one costing $150,000, and you've freed up $100,000. Subject to certain requirements, you can sell your home and realize up to $250,000 in tax-free profits if you're single; $500,000 if married.
• Another way to tap your home's equity is through borrowing. Your home's equity may be an easily tapped and low-cost source of cash (the interest you pay is generally tax-deductible).
• Some retirees also consider what's called a reverse mortgage. Under this arrangement, the lender sends you a monthly check you can spend however you want. Meanwhile, a debt balance (that will be paid off when the property is finally sold) is built up against the property.

Balancing your investment

In your zest and enthusiasm to buy a place and make it your own, be careful of two things.

• Don't make the place too weird. You'll probably want or need to sell your home someday, and the more outrageous you've made it, the fewer the buyers it will appeal to -- and the lower the price it will likely fetch. If you do make improvements, focus on those that add value: for example, skylights, a deck addition for outdoor living area, updated kitchens and bathrooms, and so on.
• Beware of running yourself into financial ruin. Changing, improving, remodeling, or whatever you want to call it costs money. We know many homebuyers who have neglected other important financial goals (such as saving for retirement and gaining the tax benefits of doing so) in order to endlessly renovate their homes. Others have racked up significant debts that hang like financial weights over their heads.