How to leverage your home equity

How much do you know about your home equity? If you are like most people it is probably one of the largest assets you have, how much do you know about it?

While this is true for most middle income families is this really a good idea? After all if it is your largest asset shouldn't you at least understand how it works?

For example what is the rate of return on your home equity? It never ceases to amaze me that families come into my office and they know exactly what the rate of return is on the CD they own down at the local bank that's worth maybe $5,000 yet they have no idea what to say when I ask them the rate of return on the $20,000 or more that is sitting in their home. Do you know what the rate of return is on your home equity?

Well to fully understand home equity consider this question. If you accumulate equity in your house is that equity going to help your home go up in value? In fact, isn't your home going to go up in value the same amount whether you have equity in it or not?

If you're not sure the answer is yes. Think about it, if you own a home that is paid off it is not going to rise in value any faster than if you own that home fully mortgaged right? The property appreciates not based on how much money you have invested in it but on how desirable a home in that neighborhood is.

So if Equity in your home isn't helping it to appreciate in value then what is your equity actually doing? The answer is nothing! That's right the rate of return on equity in your home is always zero.

Now from a business perspective or an investment perspective does it really make sense to keep your largest asset sitting idle earning a zero percent return? If you said absolutely not than I would have to agree with you. But, you may be saying to yourself what about the cost of that money?

The problem is most people are under the impression that in order to access the money already in their home they will have to pay so much in interest that it just isn't worth it. After all if you have to pay 6% or more to borrow that money out from your home wouldn't you need to make 9% or better on anything you might invest in just to make a profit? And doesn't investing your money at 9% mean that you have to take major risks with that money in order to get ahead?

What if I told you that this is not the way it works at all? And that in fact you could borrow out that idle money at 6% cost and invest it conservatively at 6% returns and still make a hefty profit over time. I know this seems impossible but if I could prove it to you would you be interested to learn more? Well check this out... Let's say that you have $10,000 in home equity and you borrow it out at a cost of 6% per year as stated above. What would that cost you over the next 30 years? Let's do the math. $10,000 x 6%= $600.00 per year. So over the course of 30 years it cost you $18,000 (30years x $600= $18,000). Now most people stop right here and say, see I told you it would cost too much money, I am better off leaving my money in my house. Who would want to pay $18,000 just to borrow $10,000? Well what about the other side of the equation? Let's now take that $10,000 and invest it at a conservative 6% rate of return over the same 30 years. $10,000 invested at 6% over 30 years grows to $57,434! So the question is would you be willing to pay an additional $18,000 in interest to end up with an additional $57,434 in assets?

I bet you didn't think you could borrow money at 6% and only earn 6% and still make money did you? The reason this works is not magic its just mathematics. The money you borrowed you paid simple interest on and the money you invested earned compound interest. That is why you come out so far ahead.

Now imagine you could write off the interest on that loan as a tax deduction. (And in most cases you can) How much did the loan actually cost you if you could write it off? Even less right? But even if you can not write it off it still works out pretty good for most folks. Also you might want to keep this in mind. What if you could earn more than a meager 6% on your money? How much better off could you be?

The point is the above example mathematically proves that there are much better things you could do with your money than just leave it sitting idle in your home. And more importantly the only thing we have discussed so far is the mathematics of investing your home equity but in reality there are many other issues to consider. Such as, is your home equity really safe or could it lose value over night? Can you access your home equity when you really need it? And so on.