The Equity for Liquidity Tradeoff
Using your home to fill a liquidity need.
Most homeowners have thought about it. When looking up your home’s algorithmically appraised value online, you begin to think “should I tap into that?”. After all, things are only getting more expensive and we’re not getting any younger. YOLO, as they say.
According to Freddie Mac, the prevailing rate for a 30-year mortgage has declined to 6.6% today from a decade high of 7.79% last October. This reduction equates to a monthly savings of $65 per month per $100,000 in mortgage debt.
The massive surge in home values combined with a pullback in mortgage rates, which could be temporary, presents homeowners with a tantalizing question: Should you tap into your home equity to satisfy a liquidity need now?
The answer to this question depends on two factors. First, what is it you’re trying to accomplish with the money? Are you simply wanting to deposit the funds in a bank account for warm and fuzzy feelings or are you driving toward a specific goal? If the objective is to accomplish a goal, could this possibly generate a return on investment (ROI) or is it purely an expense?
Second, what is your future cash flow situation? Is your future income relatively secure or could your name possibly be on the restructuring consultant’s clipboard? These things matter.
Full disclosure, I am strongly biased to avoid debt. When it comes to building wealth consistently over time, excessive use of leverage disrupts more than it helps. When I hear people use the term “OPM” (other peoples’ money) in a positive context, I conjure up images of Wiley Coyote trying to catch the Road Runner. It’s a fool’s errand.
That said, occasionally it makes sense to leverage our homes to finance a fruitful future. One example would be to inject liquidity into a growing small business to hire ahead of an employment need, which would ultimately be quickly repaid. Another could be to consolidate debt after you have sufficiently redressed the issue that got you into debt. The goal is to improve the velocity of your net worth growth.
Just for fun, here are my top ten worst reasons for tapping into your home’s equity:
Tay Tay concert tickets
Gambling
Supplement your unemployment income while you wait for that perfect job offer
Vacation
A pool (this one hurts, I know)
Investing (stocks, crypto, real estate, etc.)
Just to have cash on hand
Buying a motor vehicle (car, boat, motorcycle, etc)
To pay off Federal student loans (rather, consider SAVE plan)
Start-up business funding
Of course, bad ideas abound, and this list is not comprehensive. Using your home equity as an ATM can be tempting, especially to a liquidity deprived individual. It’s generally a bad idea that will only hamper your net worth growth over time.
There are folks out there arguing that homes are not an asset, but rather, a liability. Therefore, they should always be leveraged. For those that believe the home is not an asset, have fun sheltering from the rain and snow under your leveraged portfolio of digitized holdings. At the end of the day, some things are more real than others.
Your home is an indispensable asset if your goal is to live a comfortable life protected from the elements. True, you could rent, but isn’t renting just enabling another person to own real estate as an asset?
When using home equity leverage irresponsibly, you may lose more than you bargained for should your cash flow dip below the threshold necessary to pay creditors. Paying off your mortgage substantially reduces the risk that a claim could be made against you that would compromise your shelter, and therefore, your quality of life. For this reason, it’s a good idea to have a fully paid off home prior to retirement.
Of course, this goal may not fit everyone. Some retirees desire to travel extensively or reside in high-cost real estate markets. If this is you, just know that your retirement will be more vulnerable to the deteriorating effects of inflation. In other words, you will need to save more. I find this to be a very small percentage of retirees, however.
Most of us naturally feel like having a paid off home is a good thing. Listen to this instinct because it is telling you a deeper truth that we intuitively understand but cannot always articulate. That is, debt comes easy, but income takes work. Don’t over commit.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Securities offered through LPL Financial LLC. Member FINRA/SIPC. Advisory Services offered by National Wealth Management Group LLC, an SEC Registered Investment Advisory and separate entity from LPL Financial LLC.