Amid mounting anxiety over the state of the economy, a growing number of Americans are sinking deeper into debt. In the past few months, mortgage balances alone increased to $12.14 trillion.
Total household debt has hit all-time highs, rising by $16 billion to $17.06 trillion in the third quarter of 2023. Meanwhile, American credit card debt surpassed the historic milestone of $1 trillion in August.
However, for some, debt can be a powerful tool to amass more wealth, paving the way to financial prosperity.
In the overall financial picture, debt is merely a tool – the outcome depends on how the borrower uses it. Some of the most leveraged individuals are also the wealthiest on the planet, who are using debt to their advantage to gain assets and expand their portfolios.
Unlike regular consumer debt, those who have built up assets in their name, whether in stocks, bonds, property, or elsewhere, are in a prime position to use their equity as a pillar of their investment plan. Understanding how to harness equity to further boost net worth and spending power can transform a person’s quality of life.
Home Equity
Owning the roof over your head can do much more than ensure physical and financial security. It can open the door to an ongoing pathway toward wealth. That’s where the concept of equity comes in.
Equity is the portion of a home owned by the homeowner, calculated by subtracting the sum owed on a mortgage from the property’s total value. Sometimes it can be a negative value if the mortgage balance exceeds the home’s value — typically if property prices have crashed. In most circumstances, however, homeowners have positive equity and can use that asset to generate a significant line of credit.
There are several ways of borrowing against one’s home. Some of the most popular are home equity loans, a lump sum of cash to be paid off in monthly increments, and home equity lines of credit (HELOC), which function more like a credit card. There is also a cash-out refinance, which replaces an existing mortgage with a new loan for a larger amount.
Upgraded Home Or Real Estate Value
With extra leverage credit, first-time homeowners can reinvest to either add value to their existing home through home improvement projects or build a budding real estate portfolio by buying a second investment property.
Smart remodeling starts by prioritizing projects that increase return on investment. According to Remodeling Magazine‘s 2022 Cost vs. Value Report, installing electric heat pumps, replacing garage and entry doors, and adding a street-facing stone façade to a home generate positive returns in resale value. On the other hand, adding a midrange or upscale bathroom or suite adds less than the cost in resale value.
Leveraging equity on a property is a good fit for many homeowners. Yet, with property prices reaching historic levels since the pandemic, the barrier to entry for this borrowing option is increasingly too high.
The long-venerated American dream is now just that: a fantasy for most citizens. Americans now need to earn more than six figures, at least $114,000, to buy a median-priced home, according to the latest Redfin report. Many mortgage refinancing arrangements come with closing costs and other fees. However, cheaper alternatives do exist. Investors can still access leverage by using a more accessible asset as collateral: their stock portfolio.
Portfolio Power
Securities-based loans can give those with stock portfolios extra leverage. With a portfolio line of credit, also known as a margin loan, a brokerage can lend a stockholder money against the value of their portfolio, using existing stocks, bonds, and funds as collateral.
Unlike other loans, these lines don’t require a credit check, making them easy to apply for through a brokerage. Nor do they have a set repayment schedule, making them more flexible than a mortgage. While the loan can be left outstanding indefinitely, it will nonetheless continue to accrue interest until it’s paid off.
The percentage borrowable varies, with most capping at 30 percent of the total value of a portfolio. This aligns with advice from Chicago-based wealth consultant and financial planning expert Tom Anderson, who outlines parameters for avoiding becoming over-leveraged.
Andersen recommends borrowing up to 25 percent of one’s total portfolio value. “If you had a $1 million portfolio and borrowed at a 25 percent loan-to-value (LTV) when the market fell by 50 percent, nothing happened to you,” he says, citing 2008 as a historical precedent. “If you borrowed at a 50 percent LTV and the market went down 50 percent, you were wiped out.”
Unlike income, borrowed money is not subject to high tax levels. Borrowing acts as a critical tax optimization strategy for high-income earners. As long as the interest rate on the loan remains noticeably lower than the underlying portfolio’s growth rate, such borrowing can be sustained over time.
Building assets over time is the most reliable way of wealth creation. When used correctly, equity can supercharge an investor’s efforts in this process. It is not a fool-proof solution, however. Market crashes or housing bubbles can undermine these strategies and leave borrowers in dire straits. As always, careful research, with the help of a professional financial advisor, can be the surest way to secure against such outsized risks.
This article was produced by Media Decision and syndicated by Wealth of Geeks