Wednesday, February 08, 2006

The Home Equity Myth

Ok, my professional life is going to spill over here in to my personal life just a bit, but I think it's an important point.

Most people have the notion that it's a really great idea to pay off your home and not carry a mortgage if you don't have to. I want to spend a little time and dispell this myth.

If you own a $500,000 home and owe $125,000, how much equity do you have? $375,000. (For Orange County, California this is a very conservative scenario).

Think carefully before answering this next question:

How much interest are you earning on your equity? The answer to that one is easy. Nothing, zip, nada! It's dead equity. You don't really have any extra money because it's not a liquid asset. You could sell your house but you still have to live somewhere right so there is essesntially no gain unless you move to an area that is far cheaper than your current neighborhood.

In 2004, 69% of US households were home owners. Think about the trillions of dollars of dead equity trapped in those homes. Imagine the boost to the economy if just 5 or 10% of people that had 50% or more equity in their homes, cashed out that equity and put it to work in various investments.

If you have lots of equity locked up in your home and you get laid off, fired, or hurt on the job and need some money to get through the rough spot, getting a loan from a traditional lender is going to be very difficult and very expensive. They won't care that you've been making double payments on time every month, they won't cut you any slack when you have a hard time.

Wouldn't it be better to have your equity seperated from your mortgage and invested in something that pays at least as great of a return as your interest rate? I think so.

The more equity you have locked up in your home, the MORE risk you carry. If you become unable to pay for some reason, you risk getting foreclosed on and all of your equity goes up in smoke. On the other hand, if you are mortgaged to the hilt and you've put the balance of your equity in other instruments, the bank is carrying the risk for you. If you lose your home, you already have your equity taken out. Chances are though, if you have your equity safely tucked away in other places, that you will be better able to make your payment if something happens to your normal channel of funds (i.e. wages).

I could go on, but I don't want to start sounding like a commercial. Disagree with me if you dare, but be sure to back it up. I'm interested in what Res Ispa has to say about this in particular.