Are you wasting your home equity? 

The “American Dream” is and has been to own your home free and clear without any mortgage payment.

If this dream is still valid today, how can it be explained that thousands of financially successful Americans, who have the funds to pay off their mortgage, choose not to. The American Dream has been passed down to us by our parents and grandparents alike. Many Americans fear a home mortgage, particularly when they are at retirement age. This way of thinking is very outdated, although valid back in the 1930’s. During the great depression, banks were legally able to call a mortgage loan due in order to receive a much needed cash infusion. The stock market had lost over 75% of its value, un-employment was at an all-time high, and real estate values were falling dramatically. Many homeowners lost their homes because they did not have the funds to pay off their mortgage and they could not sell the home because there were no buyers at the time. Due to this horrific situation, a new way of thinking was born. “You should own your home and never carry a mortgage”. This way, if the economy dropped suddenly and you lost your job, you would at least have a roof over your head. Since then, laws have been past that make it illegal for banks to call your mortgage loan due. 

Today, it is no longer the case that we will live in our homes for 30 years and keep the same mortgage for 30 years until it is paid in full like our grandparents did. Today, the average person lives in their home for only seven years and according to the Federal National Mortgage Association, the average American mortgage lasts for only 4.2 years. People are moving to larger homes in better areas as well as refinancing for a better rate or to pull equity for home improvements and other expenses. These statistics show that it makes little financial sense to pay down your mortgage by applying additional principle payments and to have large amounts of equity in your home. 

Ask yourself these two questions: What rate of return do you receive on the equity sitting in your home? Would you burry $100,000 cash in your backyard? The answer to the first question is 0 or nothing! For question two, most people would answer NO, however, a vast majority of home owners across the US are basically doing just that by leaving the equity in their homes. 

Rather then allow your cash to remain dormant, pull that equity out and utilize it in any number of great investments. One option is real estate. You receive tax benefits such as depreciation, cash flow and property appreciation. Another option would allow you to invest those funds as a private mortgage loan secured by real estate and earn double digit returns on your money collateralized with real estate. Both of these options make you money! Isn’t that much better then having the equity sitting in the walls of your home making you nothing? 

Even if you were to pull $100,000 of equity from your home in the form of a Home Equity Line at an interest rate of 7% ($7,000 annual cost) and placed those funds in a safe interest producing asset which produced a return of 7% ($7,000 annual gain), would you be exactly even at this point? The answer is NO! The interest you pay on your equity line is tax deductible (mortgage interest is 100% tax deductible in most circumstances) therefore, the true cost of the 7% loan is actually only 4.55% (assuming a 35% tax bracket). It is not difficult at all these days to find an investment vehicle which produces a 7% return. 

Another problem with all that equity sitting in your home is that if sued you risk losing it. You want to look cash poor when an attorney looks at your assets. If liens show up against your homes and it appears you have very little or no equity then it may keep you away from a lawsuit. Most attorneys won’t work for free. If they can’t find a way to get paid through your assets then they won’t file the lawsuit. 

In closing and most importantly, it is a very wise decision to separate the equity from your home to prevent losing it. If you have an equity position in your home and the home values in your area decline, you will lose that equity. If you separate it from the home, via an equity loan for example, you secure the equity by converting it to cash which then may be used for safe & conservative investments. According to a recent study, 67% of Americans hold the majority of their net worth in personal home equity. If we were ever taught to diversify our investments, this statistic shows a failure to practice that advice.

Will Barnard – Managing Partner – Nationwide Property Investments, LLC – Jan. 08′.

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