| Would you think it odd behavior for someone to hide thousands of dollars in secret places though out their home? Or, even stuff old tin cans with cash and bury them in the backyard? Does that sound crazy to you? Well, at least they will always have cash when they need it. Financial professionals call that high liquidity. Liquidity is an asset's ability and quickness to convert an asset into cash. Of course if one forgets where they put their treasure or they unexpectedly die than it's gone until a treasure hunter stumbles upon the cache. Is this type of saving safe? |
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Is the hidden cash secured? The risk of losing this hidden cash would depend on the house not burning down or some natural disaster like a flood not happening. And, it would also depend on the security of the hiding places. Finally, the home owner is at risk of theft. It's impossible to replace stolen cash.
Do you think the home owner gets any return on his hidden cash? Well if he hides his money in his house and his house appreciates each year does that mean the money hidden in his house grows in value too? If you put $1000 in your sock drawer and your $200,000 house appreciates in value, say 4 percent, does that mean your sock drawer now has $1040.00 in it.
Equity is the market value of your house minus the amount of all the mortgages and liens against the house. In other words it is the homeowner's hidden cash in his house. How does home equity compare to cash stuck in the sock drawer or buried in the back yard?
Having money stashed in your house is more liquid than your equity. It's simple to retrieve money you hid in your sock drawer; you can just go and get it. To convert equity into cash you must go to a lending institution like a bank and ask for an equity loan. After two or three weeks if your credit score is high enough, your gross income is large enough and your house appraises sufficiently enough than the bank will lend you your money.
For example let's say you need a large sum of money for some home improvement project or a medical emergency. You have $100,000 equity built up in your $200,000 valued house. If you meet all of the bank's guidelines only than will the bank lend you your money. But there is a catch you can not keep your money. You must return it back to the bank in monthly installments with of course interest that you must also pay back for the privilege of borrowing your own money.
Is equity safer than cash on hand? Having cash there is always at a risk of being lost or stolen or even destroyed. Your equity cannot be stolen and you can replace it if your house has been destroyed if you have a well written homeowner's insurance policy. As the example above demonstrates, if you want to borrower your equity from a bank, but you don't qualify, then your equity is even safe from you.
You can lose your equity. The housing market could drop thus your equity would reduce in relation to the drop in your house value. Of course your mortgage loan balance is not affected by the fluctuating of the housing market. You could also lose your equity if you become unable to make your mortgage payments. The bank would have the right to foreclose and sell your home and deduct any expenses, fees and charges that they incurred during this process. In other words the bank will end up with the money to pay off your loan and your equity.
Finally, like the cash in your sock draw you may be surprised to know that your equity earns no rate of return. Although your equity may increase if the value of your home increases it can also drop with the lowering housing market. Your house can generate equity. Equity in your home can not grow by itself and your house does not require you to put any money into it (called principal) to appreciate in value. Principal is the portion of your monthly mortgage payment that reduces the mortgage loan balance.
No responsible professional financial planner would recommend hiding large sums of money in or around your house. Financial professionals have in recent years advanced the idea that you should not put any equity in your home either. In other words refrain from paying any principal on a mortgage thus leaving your mortgage balance unchanged. This strategy is used as part of what they call the "Equity Seperation Management approach". As a way to maximize the liquidity, safety, and increase the rate of return of the money one invests. Property owner would divert the money he would normally put into his property and instead put it into a safer, investment instrument which would give these funds a greater return and thus increase the homeowner's wealth.
This idea is not new. For years homeowners have taken their equity to pay for home improvements, college tuition for their children, vacations, and other assets like a new car or pool. Some people have even leveraged their equity and bought additional real estate as investments.
If you searched for equity management on the internet you would get approximately 100 million hits. This web site advocates "Equity Management" as a potentially powerful approach to generate, leverage, and accumulate wealth. But, like all things in life there are many different spins to this approach. And, many of these professionals market their ideas to upper income individuals who are already experienced in saving and have significant financial resources in investment and retirement accounts. Is "equity Management" a plausible approach for the average middle class individual who has difficulties making ends meet and save for his retirement. Equity is a source of wealth but, the crucial question is how to manage it and utilize its potential for your own individual needs and goals.
You can not acquire equity unless you own real estate. We invite you to carefully explore this entire web site. Take advantage of the resources and information that it contains so you can take part in the American Dream of home ownership. And, start growing your own Money Tree.
| Austin F. Ryder |