Investing your home equity can be a smart idea, but you have to take the time to consider your motivations, figure out your end game, and learn about the risks involved. What would you do with the equity that you’ve built up through your properties? How can you tap into it safely?
Using your home equity doesn’t only make sense, but it could also give more asset protection and opportunity to leverage your assets. Here are a few reasons why you should consider tapping into your home’s equity.
1. Asset Protection
Debt Can Be A Good Thing
A lot of people think of debt as a bad thing, but instead of seeing it as something that should be avoided at all costs, sometimes it’s good to look at it like an investment. The right kind of debt can protect you from lawsuits and claims. It can also give you some breathing room if your assets are frozen or otherwise inaccessible.
Home Equity Line of Credit
A HELOC is just like a regular line of credit, except that it uses a real estate property that you own as collateral. You can draw on the funds in this line of credit when needed.
This might be useful in situations where you’re facing a lawsuit and need cash to defend yourself. If you win, you can pay back the loan—and if you lose, you can’t repay it anyway, so you won’t be out anything either way.
This is also useful if you’re buying an asset that might appreciate significantly over time—and with property prices increasing rapidly in many parts of the country, this could be an attractive option for real estate investors.
Before Applying For A Loan
However, in order to use debt as an asset protection tool, you need to make sure that you are fulfilling the two main requirements for protecting your assets via debt:
1) you are borrowing in a way that does not impair your ability to pay principal and interest on the loan;
2) you are using the borrowed funds for an appropriate asset with an appropriate amount of insurance coverage.
Borrowing money in ways that could impair your ability to pay principal and interest payments is not necessarily bad from a risk management perspective—it could be used to hedge against risk in other areas by creating offsetting positions. The key is making sure that you protect yourself against any losses that might result from these.
2. Home Equity Has No True Rate of Return
If you have $400k in the bank today, you know what you’ll have in ten years: $400k. In the same way that a savings account is not an investment, home equity is not liquid.
You can’t invest home equity elsewhere; it doesn’t work for risk mitigation because it doesn’t have any market risk; and it doesn’t give you any yield or income that other investments can provide.
Home Equity Has No True Rate of Return
While you may be thinking of it as an asset, it’s actually just a side fund that depends on two things: appreciation and obtaining money by refinancing your mortgage if you owe more on the house than it’s worth. Neither of those is guaranteed to happen.
For example, let’s say you take out a $400k mortgage with an interest rate of 4% and an amortization period of 30 years. Your monthly payment would be $2,544 and your total interest over 30 years would be $246,000 and your total principal paid off would be $792,000. Despite this, you’re still “investing” in something that has no true rate of return at all (unless it appreciates) because your home equity only grows as a function of real estate appreciation and mortgage reduction.
Market Volatility and Unforeseen Events
Home equity can fail to grow when the market stagnates, or even goes down, and mortgage payments are not a reliable way of reducing a balance. This is because in the case of refinancing, you can only lock in an interest rate for the life of the loan, and these can rise at any point.
Additionally, if you have a variable-rate loan (most mortgages are) then you will be subject to whatever increase or decrease comes with interest rates. And if you miss a payment, even if it’s due to some unforeseen event like illness or job loss, then your entire credit score will go down, which will affect the rate you get on any future loans—meaning that your “safe” investment may not be so safe anymore.
3. More Opportunities to Build Wealth
By using your home equity, you can gain access to more financial opportunities than if you were only using cash where available. It allows you to put your money to work in more places, which increases its potential for investment returns.
Since you’re always going to have a roof over your head, you might as well use what you have to make the biggest investment possible in yourself and your future—which means buying more income-producing assets with the money you have.
Investing Safely
Using your equity to invest in real estate is not only a smart way to compound your wealth, it’s also an opportunity that’s relatively safe. Real estate is generally considered one of the safest investments because real estate has historically returned 7% annually on average (when adjusted for inflation). That’s far higher than the average historical return on stocks and bonds, which are around 3% per year. This means that over time, you’ll likely see a higher return on investment (ROI) by investing in real estate versus stocks or bonds.
Tax Benefits
In addition, taking out an equity loan lets you take advantage of tax shelters that are only available for investment purposes. In this way, not only can you make better use of your capital by growing it faster and increasing its potential returns, but you can also create tax savings for yourself or even defer taxes completely—something that’s impossible to do with cash alone.
