Is Home Equity a Good Investment?
Liquidity, safety, and rate of return are commonly used as the test of a prudent investment. Turns out keeping your equity in your home fails all these tests, here is why….
If you suddenly experienced challenging ﬁnancial times, would your rather have $25,000 in cash so you could continue to pay your bills, or would you rather have $25,000 of equity trapped in your home?
The biggest secret in real estate is that your mortgage is a loan against your income, not a loan against the value of your house. Without income, if you do get a mortgage it is at much higher rates. (ask me about the Equity Advantage program if you have low reported income)
Being house rich and cash poor is a dangerous financial position. It is better to have access to the equity in your home and not need it, than to need it and not be able to get at it.
Canadians believe that home equity is a very safe investment. It is estimated that Canadians keep 76% of their net worth in their real estate assets and for most, this translates into equity in our principal residence. Leaving large chunks of untapped equity in your home is like putting all your eggs into one basket and goes against the most basic financial principle of diversification.
Rate of Return
Liquidity and safety are the key principles when accessing equity from your home. The rate of return is a distant third objective.
Paying down a mortgage is the equivalent to investing with a rate of return that is the same as your mortgage rate. If your mortgage rate is 3%, you’ve earned 3% on the money you use to pay down that debt. Not a great return given the lack of diversification, lack of liquidity, and the alternatives available.