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Home Equity Management:
Making the most of your mortgage dollars

For most of us, the largest investment we 'll ever make is in our home. But it's an investment that comes with a hefty price tag.

That price tag goes far beyond interest payments, mortgage insurance, property taxes, buying points, "junk fees" and real estate commissions. The largest cost in truly “owning” our home – that is, in paying it off completely – comes from lost investment opportunities.

Say, what? Isn 't it the American dream to own our own home? Perhaps, but making use of your home equity through home equity management might bring greater rewards in the long run. Consider the following rationale for keeping a minority equity – no more than 20 percent – in your home.

Low Interest Rates Interest rates are at their lowest in decades, with rates dipping well below the 7 percent mark for mortgages. Why not take advantage of borrowing at 7 percent when the stock market has averaged 11-14 percent over the last 30 years?

Leverage If you own a home valued at $200,000, and it appreciates 5 percent per year, what 's your one-year return on investment if you have 20 percent ($40,000) down?

You put $40,000 down, the home is now worth $210,000, leaving you a 25 percent return on investment – a $10,000 appreciation on $40,000 down payment.

But let 's say you heed your father's advice: Neither a borrower nor a lender be. You put as much down as you can, say 50 percent ($100,000), and are determined to accelerate payments so you'll be debt-free as soon as possible.

Your home appreciates at the same rate, 5 percent, but your return on investment is only 10 percent ($100,000 invested to return $10,000). If your home will appreciate at the same rate regardless of the amount invested, doesn 't it make sense to invest the minimum, and use the difference ($80,000 in the example we just used) to invest in mutual funds, or some other growth and equity investment? (Remember, investing in mutual funds should be a long-term process.)

Safety But what about safety? When your cash is tied up in your mortgage, what if you lose your job? You 'd live off savings for awhile, but when that runs out, how do you make your mortgage payment? Banks won't loan you money on that beautiful equity you've built up without a job. So, the next recourse is to sell your assets, the largest of which is your house. But because you're desperate, you may not get top dollar. You now have your equity back, but no house. If instead of tying up your cash reserves in your mortgage, you'd put them in a liquid, interest-bearing account, you could have used that money to live on – and saved your house in the process.

Time Value of Money What about the interest you must pay on a large loan? Over time, it adds up to big dollars. By investing more of your down payment elsewhere now, you 're investing the spread – the difference between what you pay for the loan and what you'll earn on your investment elsewhere – now, when the dollars mean more.

The reality is that most Americans don 't live in their homes for 30 years. In five or six years, they'll probably move, transferring their down payment dollars and some appreciation into their new home.

What if you used the extra monthly cash flow you 're not putting toward a higher mortgage into an investment vehicle? You can do that. But most of us don't. It's more difficult to save regularly than to put a large lump sum away. In the chart below, note that $20,000 invested rather than included in the down payment can result in a $221,480 difference over 30 years.

Some Caveats If all this sounds too good to be true, it isn 't. It is important, though, that you follow some basic rules of home equity management.

• Don't be greedy. A smaller down payment makes sense, but avoid those “nothing down” mortgages with high-interest loans. With less than 20 percent equity in your home, you'll probably be socked with mortgage insurance premiums. These can add $50 per month to a $100,000 loan. In addition, you'll be paying higher interest rates, reducing the advantages of home equity management.
• Don't go on a shopping spree. Home equity management only makes sense if you invest the dollars you're not using toward a down payment. If you're afraid you'll spend the money, it's best to keep it in your home where you won't be able to easily access it.
• Keep tabs on your equity. It pays to re-evaluate your situation every few years. If interest rates have dropped, maybe it's time to refinance. Has your equity grown to 30 or 40 percent? You may want to take out a home equity loan to get back to a 20 percent ratio. Just remember to reinvest those dollars.

To arrange a mortgage planning consultation on strategies discussed in this article, please call MYBLACKJACKET.COM at 949-481-9026