If you’re like most people, your home will be the biggest investment you’ll ever make.
Many people have been led to believe that their home equity is their greatest asset, which may or may not be true depending on a number of circumstances.
Your home equity is the value of your ownership position in your home. You can quantify the equity in your home by subtracting any outstanding mortgages from the market value of your property. The difference is the value of your interest in your home, the equity in your home.
Considering how important your home equity is, what then is the most advantageous way to wisely manage this equity throughout your ownership?
The best home equity management plan will differ from person to person and will depend largely on an assessment of your individual financial circumstances.
Hopefully, this article will give you enough information to help you plan wisely when it comes to managing your home equity.
How secure is your home equity?
Most people confuse security with stability. Money in the bank, certificates of deposit (CDs), and some savings accounts are stable in that you will never lose your money. But the biggest enemy of all these elements are:
- Taxes
- inflation and
- opportunity costs
The biggest threat to your home’s equity is the volatility (up and down movements) of the housing market. In the late 1980s and early 1990s, many homeowners around the world watched their home equity disappear before their very eyes. Thousands of homes were foreclosed on as people lost their jobs and were unable to make their mortgage payments. As a result, most homeowners lost the value of their home.
An economic downturn may be highly unlikely today, but are there other external enemies to your home equity that you have no control over?
Simple factors like neighbors from hell or an incinerator being built across the street or even just a few blocks away can immediately affect the value of your home equity.
Another big threat is unexpected redundancy. If you run out of your cash reserves and find yourself without a job or source of income, this will put you in the most difficult position if you can’t keep up with your mortgage payments. Do you feel like going to any mortgage provider and telling them,
“My house is currently valued at £350,000 and I only owe £225,000, so I have £125,000 of home equity. I have always had a job and kept up with my mortgage payments. I am a professional with qualifications, credentials, and references. It’s only a matter of time before I get another good paying job. Please lend me £20,000 of my real estate to keep a roof over my family until I get back on my feet.”
What do you think will be the response of any lender?
“I’m an income lender, not an equity lender. I have charges on thousands of homes and I don’t want to own your home on top of that. Show me your ability to pay me right now and I’ll look favorably on your application.”
Your income is your evidence of your ‘ability to pay’.
Your home will most likely be foreclosed on if you are unable to pay your mortgage, no matter how small. The number one reason for repossession or foreclosure is disability; Reason number two is job loss.
The equity in your home is not secure.
How liquid is your home equity?
How easily can you convert your home equity to cash or separate it from your property? Can you charge it at any time? To convert your home equity to cash or separate it from your property, you must:
- sell your house
- Refinance the original mortgage
- Get more advances from your current lender
- Get a new first mortgage from another lender (Re-mortgage)
- Obtain a second mortgage or
- Get a home equity line of credit
The first option requires you to give up your house. The next three options require financial subscription. Remember, lenders are income lenders, not equity lenders. They want to know what capacity you have to pay them back the money you want to borrow. The possibility of being approved for a loan or any line of credit is when you don’t need it. Ironically, this is when you look your strongest financially.
So it’s a good idea to make sure you have a pre-approved home equity line of credit now, or cash in some of your home equity for reserves you can access right away.
The equity in your home is not liquid.
Does your home equity earn a rate of return?
Don’t confuse home equity appreciation with a rate of return on your home equity. Your home’s value may appreciate, but it certainly doesn’t earn you a rate of return or interest.
Strictly speaking, your residential property is not an investment asset for that reason. In fact, it is a liability because it is something you pay for, it does not generate income, except when you choose to use the capital that accumulates in it.
As you consider the smartest way to manage your home equity, consider the following:
- Your Home Equity Is Not Safe
- Your home equity is illiquid
- Your home equity does not give you a rate of return
So the equity in your home is a dead asset. It’s not safe, it’s not liquid, and most importantly, it doesn’t earn a rate of return. It is a lazy asset.
Depending on your individual financial circumstances, there are compelling and compelling reasons to release your home equity for investment purposes. In fact, when you sit there, you’re incurring opportunity costs because your capital isn’t working for you like its monetary equivalent does, and you’re also not invested in a vehicle that will give you decent investment returns.
