How much would you want to invest in something that could never go up in value, but only go down?
Well, zero. Right? That sounds awful.
However, a substantial amount of your net worth is probably tied up in this vehicle right now. It’s called home equity.
Home equity is the difference between what your home is worth and the amount that you owe on the loan.
For example, let’s say that you have a $300,000 home with a $200,000 mortgage balance. You have $100,000 in equity.
Well, if your home appreciates in value to $400,000, congratulations. But let me ask you: “Did that appreciation depend upon how much equity was in your home?”
Conversely, if your home plummets in value down to $200,000, did the equity in the home contribute to the depreciated value?
Additionally, in the latter scenario, your home value took a 33% haircut, but your equity was 100% wiped out.
Home equity does not contribute to your market value increase. But if it’s left exposed to the market, it can all be taken away from you in a downturn.
You can protect yourself from fire and natural calamities with homeowners insurance. But there’s no such thing as “home equity insurance”.
Equity has nothing to do with market value. Market value depends on forces outside the walls of your home like population growth, housing supply, and local employment vibrancy.
In fact, the following are all true about home equity:
- It is unsafe.
- It is illiquid.
- It’s rate of return is always zero.
Unlike in Depression-Era days, the bank cannot just call your entire loan balance due at will.
Well, shouldn’t everyone know this stuff? Yes, but people don’t know. Generations of financial illiteracy persist because financial education is not taught in schools.
Everyday people can manage their home equity like the affluent by separating equity from their home in order to purchase a second property.
When equity is harvested this way, your equity is not lost. It is only transferred.
Additionally, you may have added a layer of safety because your equity is now diversified into two assets in two geographies.
This second property can bring you a measure of cash flow with income property, the potential of two properties appreciating rather than one, or even an improved standard of living with a vacation property that you also rent to others.
“A house [primary residence] is not an asset. Assets put money in your pocket, whether you work or not. Liabilities take money from your pocket.”
-Robert Kiyosaki, #1 Selling Personal Finance Author Of All-Time
What about the risk of separating equity from your home?
Be prudent. As long as the income yield from the second property exceeds the mortgage interest rate and payment on your home’s new loan, you are typically dollars ahead.
More important than a Return On Investment, you can enhance your “Return On Life”.
I practice what I preach. When equity accumulates in my wife and I’s home, I separate it and reinvest it into other income-producing property.
Again, I do this for reasons of safety, liquidity, and rate of return.
“In real estate, financially-free beats debt-free”
-Keith Weinhold, Host Of One Of America’s Top Investing Shows
If you do what everyone else does, you’ll only have what everyone else has.
Many homeowners don’t realize that they can often access home equity by originating a second mortgage on their property.
You can keep your first loan in-place, untouched, perhaps continuing to enjoy the first loan’s low mortgage interest rate and advanced amortization schedule.
Think about it. When you make extra principal payments to the bank, here is what you are effectively saying: “Hey Mr. Banker, here’s an extra $100. Don’t pay me any interest on it. If I need it back, I’ll pay you fees. Oh, and plus I’ll try to prove to you that I qualify again.”
Rather than keeping equity locked up between pieces of drywall in your home for zero return, learn more about why homes make lousy banks. Homes are not meant to store cash.
Homes are meant to house you and your family.
This is such an important topic, that I devote all of Get Rich Education podcast Episode 163 to it, where you’ll learn that home equity is even worse than I outlined in the article. Click here to listen to the podcast.
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I also discuss this clearly on Get Rich Education podcast Episode #238 ?.