If you are like most people your home will be the single
biggest investment you make in your lifetime. Many people
have been led to believe that their home equity is their
largest 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 your home equity by subtracting any
outstanding mortgages from the market value of your property.
The difference is the value of your stake in your home,
your home equity.
Bearing
in mind how significant your home equity is, what then is
the most advantageous way to wisely manage this equity during
your entire ownership?
The
best home equity-management plan will differ from person
to person and will largely depend on an assessment of your
individual financial circumstances.
Hopefully,
this article will provide enough information to help you
plan wisely with regards to managing your home equity.
How
Safe Is Your Home Equity?
Most
people confuse safety with stability. Money in the bank,
certificates of deposits (CDs) and some savings accounts
are stable in terms of you never losing your money. But
the biggest enemy of all these items are:
- Taxes
- Inflation
and
- Opportunity
Costs
The
biggest threat to your home equity is the volatility (the
upward and downward movements) of the property market. In
the late 80s and early 90s, many homeowners worldwide watched
their home equity disappear right before their eyes. Thousands
of homes were repossessed when people lost their jobs and
could not make their mortgage payments. As a result, most
homeowners lost their home equities.
An
economic recession may currently be highly unlikely, but
are there other external enemies to your home equity over
which you may not have any control?
Simple
factors such as neighbours from hell or an incinerator being
built down your road or even a few blocks away can immediately
affect the value of your home equity.
Another
big threat is an unexpected redundancy. If you run out of
your cash reserves and find yourself with no employment
or source of income, this will put you in the trickiest
of positions if you cannot keep up with your mortgage payments.
Fancy going to any mortgage provider and telling them,
“My
home is currently valued at £350,000 and I only owe £225,000
on it, so I have £125,000 of home equity. I have always
held a job and kept up with my mortgage payments. I am a
professional with qualifications, credentials, and references.
It is only a matter of time before I get another well-paid
job. Please lend me £20,000 of my home equity to keep a
roof over my family until I get back on my feet.”
What
do you reckon any lender’s response will be?
“I
am an income lender, not an equity lender. I have charges
over thousands of houses and do not want to own your house
in addition. Show me your ability to repay me right now
and I will favourably consider your application?”
Your
income is your evidence of your ‘ability to repay’.
Your
home will very likely be repossessed if you do not have
the ability to repay your mortgage, however small. The number
one reason for home repossessions or foreclosures is disability;
the number two reason is loss of employment.
Your
home equity is not safe.
How
Liquid Is Your Home Equity?
How
easily can you convert your home equity into cash or separate
it from your property? Can you cash it in at any time? To
convert your home equity into cash or separate it from your
property you have to either:
- Sell
your home
- Refinance
the original mortgage
- Take
out further advances from your existing lender
- Obtain
a new first mortgage from another lender (Re-mortgage)
- Obtain
a second mortgage or
- Obtain
an equity line of credit
The
first option requires you giving up your home. The next
three options all require financial underwriting. Remember,
lenders are income lenders, not equity lenders. They want
to know what ability you have to pay them back the money
you want to borrow. The chance of you being approved for
a loan or any line of credit is when you do not need one.
Ironically, this is when you look the strongest financially.
So
it is wise counsel to ensure now that you have a pre-approved
equity line of credit, or to cash in part of your home equity
for reserves that you can immediately access.
Your
home equity is not liquid.
Does
Your Home Equity earn a Rate of Return?
Do
not confuse the capital appreciation of your home with a
rate of return on your home equity. Your home might appreciate
in value but it certainly does not earn you a rate of return
nor does it earn you interest.
Strictly
speaking, your residential property is not an investment
asset for that reason. It is in fact a liability because
it is something that you pay for, it does not earn you an
income, except when you chose to utilise the equity that
accrues on it.
When
considering the wisest way to manage your home equity, bear
the following in mind:
- Your
home equity is not Safe
- Your
home equity is illiquid
- Your
home equity does not earn you a rate of return
Your
home equity then is a dead asset. It is not safe, it is
not liquid, and most importantly, it does not earn you a
rate of return. It is a lazy asset.
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.
