Home Equity

Home Equity Myth

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.

Copyright 2006 Margaret Ntifo