Home Equity is Just a Number

by Tom Tousignant

in Blog, Wealth Building

Personal IncomeA recent Wall Street Journal story said, “More than 40% of borrowers who took out a mortgage in 2006 — when home prices peaked — are under water. Prices have dropped so much in some parts of the U.S. that some borrowers who took out loans more than five years ago owe more than their home’s value.”

After years of sounding like a voice in the wilderness, the numbers now prove what I’ve been saying: only money in the bank is like money in the bank. Home equity is not money in the bank.

The variable nature of home equity

Once you’re in a home, there are only three ways to extract money from it: sell, refinance or home equity line of credit.  Problem is,home equity can vaporize in each of the three.

Sell: You’ll lose between 6-10%of sales price on commissions and other costs — that’s given. But if you happen to try selling in a soft housing market, you could possibly lose on the sales price after a long time on the market.

Cash-out Refinance: Lenders only allow you to cash out 85% of the appraised value, leaving 15% in the house. And remember, this appraisal may come in for less than the prior one.

Home equity line of credit: The best-case scenario allows you to access 90% but a low appraisal or lender guidelines could make this option even less attractive.

This is not meant to discourage anyone from buying a home. On the contrary. Considering the tax advantages of home ownership and the quality of life that comes with owning the right home, most people should aspire to own a home of their own.

Eggs in one basket?

I advocate a balanced approach to placing long-term savings in  home equity along with other investment vehicles. A qualified financial advisor can help you diversify in an appropriate manner for your goals and circumstances. My caution to you is blindly following the advice that your first financial priority should be paying off the mortgage.

My friend Shane Tenny, Certified Financial Planner™ professional with NC-based Spaugh Dameron Tenny says, “It’s not only imprudent to have 50% of your investments in one company’s stock, it’s also just as risky to have 50% of your assets tied up in your house–an investment that’s not liquid, provides no return, and has no guarantees.”

The Financial Freedom Point

The key financial planning concept to master is the Financial Freedom Point: the time when you can use your investments to pay off the balance of your mortgage with the stoke of a pen. Until you reach the Financial Freedom Point, remind yourself of the risk that your home equity is just a number, not a reality.

Many people meet with a financial planning professional at this time of year, whether to map out end-of-year tax strategies or to chart a prudent course for the new year.

When you meet with your advisor, consider the role of the right mortgage in your overall strategy. This free guide might help you prepare for that conversation.

Click to Download Your Foundation for Financial Success (pdf)

Click to Download Your Foundation for Financial Success (pdf)

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