Successfully Managing Home Equity to Increase Liquidity, Safety and Rate of Return

by Jim McKinney, Certified Mortgage Planner

What’s the biggest secret in real estate? Your mortgage is a loan against your income, not against the value of your house. Without an income, you often can’t get a loan. If you suddenly experience financial difficulties, would you rather have $25,000 cash to help you make your payments or an additional $25,000 of equity trapped in your home? Anyone who ever lost their home to foreclosure would have been better off if they had their equity separated from their home in a liquid, safe, conservative side fund that could be used to make mortgage payments during their time of need.

In 2003, financial planner Douglas Andrew was the first to articulate the strategy the wealthy have been using for decades in his book, Missed Fortune. Doug educated his readers to view their mortgage and home equity through a different lens - the lens used by the affluent. He shows how relatively minor changes in home equity perception and positioning can produce monumental long-term effects in financial security.

Many Americans believe the best way to pay off a home early is to pay extra principal on your mortgage. Similarly, many finance professors think a 15-year loan saves you money by reducing the interest you pay. However, Doug points out that this thinking is flawed. If you set aside the monthly payment difference between a 15-year and a 30-year loan as well as the tax savings into a safe side account earning a conservative rate of return, you will have enough to pay off your home in 15 years with $25,000 to spare!

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In April 1998, The Journal of Financial Planning presented the first academic study undertaken on the question of 15-year vs. 30-year mortgages. They concluded the 30-year loan is better. Based on that same logic, wouldn’t an interest-only loan be even better than an amortizing loan? And due to the tax deductibility of mortgage interest and compounding returns, you can borrow at a higher rate and invest at a lower rate and still make a significant profit.

The Importance of Separating Equity from Your Home

In Missed Fortune, Doug suggests that people strongly consider separating as much equity as possible from their home. These three primary reasons are often used as the test of a prudent investment:

1. HOW LIQUID IS IT?
2. HOW SAFE IS IT?
3. WHAT RATE OF RETURN CAN I EXPECT?
4. WILL I RECEIVE TAX PREFERRED TREATMENT ON THE PROCEEDS OR INCREASE ON THIS INVESTMENT?

At Global Lending Group we specialize in teaching people how to use a mortgage as a financial planning tool. Allow us the privilege of showing you why home equity fails the tests of a prudent investment, and, more importantly, why homeowners benefit by separating equity from their home.