Depending on your individual financial circumstances, there are attractive and appealing reasons for releasing your home equity for investment purposes. In fact, when left sitting there, you are incurring opportunity costs because your equity is not working for you as its monetary equivalent can, and neither is it invested in a vehicle that will generate you decent investment returns. For your home equity to work for you by generating a rate of return, it must be converted into cash. The only way to do this is to obtain a mortgage on your home, or an equity line of credit, both of which will require you to pay interest on the amount borrowed over time. Consider the interest payments as the employment cost of borrowing cash against your home equity for investment purposes. The only economic benefit home equity offers is that of reducing your mortgage payments. So long as you can find investments with net returns that will exceed the cost of your mortgage interest rate, then it is a wiser decision to earn more by utilising your equity than what you pay to borrow on it. There are many investments that can easily beat the cost of a mortgage! This largely depends on ones risk tolerance and financial objectives. Mind you, risk tolerance is also dependent on how much financial acumen one has and their understanding of what is at stake. It pays to learn as much as you can and thereby raise your risk factor within reason. Let us consider the employment cost of releasing your home equity. You currently hold a mortgage of 80,000 on your property that is worth 240,000. This means that your equity is 160,000. If you took an 75% loan-to-value mortgage, you can borrow as much as 176,000, which will give you 96,000 to invest after you have repaid your original mortgage. Your current monthly repayments are 438 per month. After the re-mortgage you will be paying 668 per month, an increase of 230 per month equivalent to 2760 per annum. This will be the net cost of the extra borrowing in the first year of borrowing. 2760 over twenty-five years will be 69,000. I have not factored in tax advantages of interest only payments. Now, let us look at the opportunity costs for investing the 96,000 released. At a 13% average annual rate of return, this will grow to just under two million pounds in twenty-five years. This is a no-brainer! Would you be willing to trade 69,000 for 1,953,209? What if you could get better than 13% return on your investment? How about 25%, which would give you a whooping 24,352,197! Even an 8% return on investment would give you a decent 630,059. In many cases, most people can use their home equity to position themselves much stronger financially both now and in the future and not spend any more money than they are currently spending. By so doing, you are leveraging the equity in your residential property to get more returns, especially if you have no other way of getting on the property investment scene. Your personal residential property is not an investment! The general advice has been to it pay off as soon as possible, but not necessarily when you are starting to build your wealth. As soon as you have acquired enough assets to generate a good passive income, you can then focus on paying off your residential mortgage. Any mortgage on rental properties should be interest only. This is best for income tax purposes because the interest payments are tax-deductible whereas capital repayment is not. Having an interest only mortgage will also put you in a better cashflow situation. (Note: This is applicable to the current UK Tax provisions - 2006. The situation in other countries should be checked.) |
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