Know the Value of Your Home Equity
It is a well-known fact that investing in real estate can make you very wealthy which is why most well paid corporate professionals like to invest in real estate to ensure that their net worth grows over a period of time as their assets increase in value. What is not so well known is the fact that most people who have accumulated wealth through real estate in a single generation have done so inspite of the fact that they started out with modest means. But by spending conservatively and investing their money smartly they have ended up with a net worth of tens of crores.
You too can reach that status through real estate once you are able to understand the importance of building equity in your real estate investments. Lets understand this concept in greater detail. If you’re not a high net worth individual currently then the most equity that you own in life would be probably locked up in your primary residence where you live. But over the last decade or so we have seen that unlike earlier generations, home owners in today’s world take that equity very lightly. They ignore the importance of maintaining and growing one’s equity in their primary residence.
Don’t Treat Your Home Like an ATM
Some people treat their homes like an ATM! It is a fact that to keep up with work colleagues, friends and neighbours everyone wants to buy “that” car, “that” jewelry, branded clothes and expensive vacations. And the easiest way to pay for these is through low-interest, easy-to-acquire home equity loans that you can access easily. It is easy to get such loans against your property these days. Its easy and enticing but also highly dangerous!
Can you imagine your older parents or grandparents approving of you going out and spending the equity that you have in your family home?! They would never approve! That generation knew the value of home equity and would never erode that for frivolous purchases.
Do Not Tap Long Term Assets for Short Term Buys
Smart home investors know the value of keeping their equity intact in their residential property and do not tap their real estate equity to buy things that depreciate in value. The most important thing that a HNI (High networth individual) understands is that:
A smart person does not use a long term asset like real estate to buy short term assets like a car or a vacation.
Smart home investors regard their homes as capital assets. If anything they aim to increase their equity in this asset by paying off all home loans as soon as possible and by rejecting the barrage of salespeople and advertising that urges them to treat their home equity like their personal savings account. If you repeatedly refinance your home to pull cash out then you should ideally have an “ATM” sign outside the door of your house instead of your name plate 🙂
Two Examples
Let us look at two examples here. The first is the example of a person who sells his small company for a great price to a larger company and receives a large sum of money. He also owns a great apartment in a very desirable location. Every year he gets a bank appraisal done on his home and realizes that the property is growing in value every year by a large percentage and instead of paying the home loan off he refinances the house and pulls out more money from the bank to finance his lavish lifestyle. In a matter of years the apartment has been refinanced for more than the purchase price. By then, due to his lifestyle the man has also lost the money he made from the sale of his company. The apartment is repossessed by the bank.
In the other example, a corporate executive quits his safe and steady job at an established MNC to go work for an internet start-up where he is not paid a high salary but given a lot of stock options. Things go well at the company for a few years and the company decides to go for an IPO. Employees who own stock in the company are in line o earn a huge sum of money if they encash their stock. He asks his financial consultant about what to do with his hard-earned windfall. The question that crosses his mind is whether to hold on to his stock or cash out. He is convinced that the stock has the potential to increase even more. His financial advisor smartly suggests him to atleast sell enough stock to pay off the mortgage on his house. He considers that as a good idea and does the same. A year later the company crashes and the remaining stock becomes worthless. It was a sad situation but atleast the man’s home loan was paid off and that gave him some breathing space as he started searching for a new job!
In my career as a real estate consultant for high end properties in both the US and India, I have encountered many home sellers who purchased their homes at a high price and took out loans on the property on a regular basis. Now they owe money to the banks a sum that is more than their houses are even worth. Most of these clients are unable to understand they they cannot sell these properties for more than the loans that they have on them. They feel that the “negative equity” is unfair to them. What essentially happened was that they “sold” their property to the bank over the years and have already received the money in the form of mortgage debt. Now the bank owns their property and they have nothing. That’s the sad truth for these set of home owners.
Treat Home Equity as Sacred
Smart home buyers treat the equity in their homes as “sacred” and do not ever tamper with it. They do not treat their equity like an ATM machine. They let that equity grow in two ways:
- Through normal market appreciation.
- By paying off outstanding home loans ASAP
Smart home buyers know that appreciation does not always happen in a linear fashion. There will be highs and lows in the graph as the value of their property rises and falls over the course of their property ownership.
But they also know for a fact that always – Real Estate increases in value over the long term.
Why Real Estate Appreciates
The reasons for this are many. The price of land continues to appreciate as land is always and will be in short supply now and in the future on our planet. Materials used for development such as steel, wood, copper, concrete and even plastic become more and more expensive with each passing year. So does the cost of labour. This also means that the cost of everything that has gone towards constructing your home will appreciate over time and that will help build your equity. Smart home owners will not interrupt that process by taking money away from their equity to finance the purchase of short-term assets that depreciate in value. Of course there are times when such home owners will tap into that equity. It would happen in the case of an emergency such as paying for medical needs or for college fees (which is one of the best investments that you can make for a family member).
Let me reiterate what I have said so far in the article again:
The equity in your home which is a long-term capital asset should never be used for the purchase of a short-term asset or to cover an expense.
The only comparable similarity I can think of if you do this is by imagining that you are cutting up your antique furniture and burning it in the fireplace to heat up your home!
I hope you have taken some valuable insights from this article that will make your appreciate the value of your home and protect your equity not only for yourself but also for your future generations!
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