Skip to main content

The Myth of Taking Equity from Your House

You aren't smarter than the market. It really is that simple.

The idea that you can "take money" out of your home is a common myth that gets a lot of people in trouble in a hot real estate market. It is a myth that is based on several misunderstandings that are often repeated.

Myth 1: When an investment you own goes up in value you have "made money."

In fact, you only make money from an asset's appreciation when you sell the asset. Until then, the current valuation is just an estimate of how much money you will make when you actually sell it. As long as you still own the asset, the value you will get is still in play. It isn't money. This is particularly important with a home. If you want to take your profit out of your house you have to sell it and that usually means replacing it with another home.

Myth 2:  Refinancing  "takes your equity" out of your house.

This myth is particularly pernicious. In fact, the description of people "using their home like an ATM" feeds the notion that you are simply using money you already have.  But a more apt comparison for getting cash by refinancing your home or taking out a home equity loan is that it is like using your credit card for a cash advance. Like a cash advance on your credit card, you are simply taking out a loan on which you will have to make payments, including interest.

Of course the advantage of a home equity loan, or a refinance, is that the interest you pay is lower and the term of the loan is often longer. This means lower payments and lower total costs than a similar cash advance on your credit card.  Those advantages result from your putting up your home as collateral. If you don't make the payments, the lender takes your house and sells it to get repaid.

Myth 3: You will at least get a tax deduction for interest on a home loan

Even before the recent tax law eliminated the tax deduction for home equity loans that weren't used for home improvements, the value of this tax deduction was misunderstood. Almost 80% of taxpayers do not itemize, instead they take the standard deduction, currently $24,000 for a married couple. So they have no ability to take a deduction on their mortgage interest.

But even many people who do itemize are only recovering a small part of their loan interest. This is because they don't have $24,000 in other deductions. The result is that a substantial part of the interest deduction is just replacing a portion of the standard deduction they would have received anyway.  Consider that 5% interest on a $500000 loan is $25,000 and if you have no other deductions, that is only $1000 added deduction. The tax savings in the 24% tax bracket are less than 1% of the interest paid or .05% of the loan value.

Refinancing your home, home equity loans and home equity lines of credit all have their purposes. They are often a low cost way to borrow money. But you are borrowing money, not harvesting the proceeds of your investment. As many people have discovered when a hot housing market turned cold and they were stuck with a house they couldn't afford to sell. Or worse, lost their home when they couldn't make the payment on all that "equity" they "harvested".

\

Comments

Popular posts from this blog

Who is to blame for this mess?

There seems to be a lot of discussion to who is to blame for the financial crisis. But an awful lot of the media coverage is highly misleading. Here is synopis: 1) The meltdown in the financial market had little to do with people getting mortgages they couldn't afford. The collapse of the mortgage backed CDO's was caused by the collapse in the value of the houses which provided the collateral. It turned the mortgages behind the "collateralized debt obligations" (CDO's) into mostly un-collateralized debts. The result was that they went from AAA rated bonds to junk. 2)So what caused the housing bubble and collapse? Many people blame the fed, but don't have the story right. The fed did play a role. By keeping interest rates on Treasury Bonds low, they provided a market for alternative bonds that would pay a greater return. But the major cause of the housing bubble was the creativity of the investment banks. These are not the retail banks that make home mortgages ...

The Stock Market hasn't gone up, the Value of the Dollar has Just Gone Down.

You aren't smarter than the market. It really is that simple. The New York Times had an article about the stock market's recent gains. The story noted that while the market had gone up 11% since the election, the dollar had dropped 10% against a basket of foreign currencies during that same period. They described this as "almost a mirror image." Unfortunately it is exactly a mirror image for people who hold those foreign currencies. Lets say they paid a $100 for a share of stock the day of the election and they exchanged 100 units of their own currency for that $100. Now if they sell that stock they will get $111 dollars, but when they exchange that $111 dollars, they will get back 100 units of their own currency. They have earned nothing, in their own local currency's terms the price hasn't changed. In a world investment market, the price of stock is set by what people around the world are willing to pay for it. Most people are still paying the same pr...

Self-Directed Real Estate IRA's the New Scam?

You aren't smarter than the market. It really is that simple. You know the marketing folks have been out talking when the New York Times does a fluff story on some new way to make more money with your investments. So watch out for the new scam promoted by the same media advisers who told you a few years ago to buy the most expensive house a lender would finance. Paul Sullivan story is about people'e successful investment of their retirement money in real estate using a self-directed IRA. He provides us with several "success stories".  Of course they are all recent converters to this idea and, not surprising, all but one of the people whose story Sullivan tells are also in real estate sales. The problem isn't really Paul Sullivan. Its that there is no one who makes money by digging out the horror stories from people who invested their retirement funds in real estate at the height of the housing bubble. There aren't any public relations firms devoted to de...