Depending
on your individual financial circumstances, there are attractive
and appealing reasons for releasing your home equity for
investment purposes. In fact, when left sitting there, you
are incurring opportunity costs because your equity is not
working for you as its monetary equivalent can, and neither
is it invested in a vehicle that will generate you decent
investment returns.
For
your home equity to work for you by generating a rate of
return, it must be converted into cash. The only way to
do this is to obtain a mortgage on your home, or an equity
line of credit, both of which will require you to pay interest
on the amount borrowed over time.
Consider
the interest payments as the employment cost of borrowing
cash against your home equity for investment purposes. The
only economic benefit home equity offers is that of reducing
your mortgage payments.
So
long as you can find investments with net returns that will
exceed the cost of your mortgage interest rate, then it
is a wiser decision to earn more by utilising your equity
than what you pay to borrow on it. There are many investments
that can easily beat the cost of a mortgage!
This
largely depends on ones risk tolerance and financial objectives.
Mind you, risk tolerance is also dependent on how much financial
acumen one has and their understanding of what is at stake.
It pays to learn as much as you can and thereby raise your
risk factor within reason.
Let
us consider the employment cost of releasing your home equity.
You currently hold a mortgage of £80,000 on your property
that is worth £240,000. This means that your equity is £160,000.
If you took an 75% loan-to-value mortgage, you can borrow
as much as £176,000, which will give you £96,000 to invest
after you have repaid your original mortgage. Your current
monthly repayments are £438 per month. After the re-mortgage
you will be paying £668 per month, an increase of £230 per
month equivalent to £2760 per annum. This will be the net
cost of the extra borrowing in the first year of borrowing.
£2760 over twenty-five years will be £69,000. I have not
factored in tax advantages of interest only payments.
Now,
let us look at the opportunity costs for investing the £96,000
released. At a 13% average annual rate of return, this will
grow to just under two million pounds in twenty-five years.
This is a no-brainer! Would you be willing to trade £69,000
for £1,953,209?
What
if you could get better than 13% return on your investment?
How about 25%, which would give you a whooping £24,352,197!
Even an 8% return on investment would give you a decent
£630,059.
In
many cases, most people can use their home equity to position
themselves much stronger financially both now and in the
future and not spend any more money than they are currently
spending. By so doing, you are leveraging the equity in
your residential property to get more returns, especially
if you have no other way of getting on the property investment
scene.
Your
personal residential property is not an investment! The
general advice has been to it pay off as soon as possible,
but not necessarily when you are starting to build your
wealth. As soon as you have acquired enough assets to generate
a good passive income, you can then focus on paying off
your residential mortgage.
Any
mortgage on rental properties should be interest only. This
is best for income tax purposes because the interest payments
are tax-deductible whereas capital repayment is not. Having
an interest only mortgage will also put you in a better
cashflow situation. (Note: This is applicable to the current
UK Tax provisions - 2006. The situation in other countries
should be checked.)
