Equity is what?

Roger Schlesinger
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Posted: Nov 10, 2006 12:00 AM

So many people do not understand what the equity in their house is all about. I admit that is a bold statement, but one that I know from experience is true. Every day I discuss people’s finances with them and they fail to take into account the value of their equity. Let me make some simple comparisons. If you had a CD in the bank, that would be an asset that is easily converted to cash. If you had stock that is traded on one of the exchanges, that is an asset that can also be readily converted to cash. Commodity contracts that are traded, gold and silver coins, rare art and precious stones are all assets (if they are yours) that can be converted to cash.

Two primary ways to do that are to sell the asset or borrow against the asset.

Equity in your house is a similar asset. It is the difference of the value and the loan(s), if any, that you have on the house. You can sell the house and the equity becomes cash, or you can borrow against it, just as I suggested in all of the examples above, and secure the cash you need. With that comment, I know dozens of people will be writing telling me that I am giving people the wrong idea. They will say you can't borrower and come out ahead. My question to the critics: "When is it okay to use your own money?"

Your money is your money! Having said that, there are scores of people who have very definite opinions on when you should be allowed to use your money. Please realize that their opinion and mine is irrelevant to you, but too many homeowners with equity are influenced by others with what I believe is faulty information.

Money is important to maintain a standard of living at every level. Money should be saved for emergencies and for eventual retirement at the very least. I have always felt that a house that is free of encumbrances is the best of all retirement vehicles. But I also believe that people must put their money to work at the highest and best use, as it is a rare resource. So it is now time for me to give my opinion as I am writing the column:

1. Credit cards that carry double-digit rates should be paid in full each month. If they cannot be paid, then money should be taken from the house to retire the cards and cancel them.

2. I would never take money from my house to pay for a vacation, nor would I charge a vacation unless I could pay it off within a month.

3. The two most important items following food and lodging are health insurance and disability insurance. Take money from the house for these payments if you cannot make them with your income.

4. Everyone should have six months of total monthly outlay in the bank for reserves. A year is better. You must take money from the house for this and if you can save it up, pay the money back.

5. Never take money out to pay low interest student loans.

6. Capitalizing on 401k employer contributions is a must. Take money for this to maximize the matching contribution.

7. You should pull cash out for other retirement vehicles that are tax deductible if you need the write off and are in a prudent fund. Always check with your tax adviser before doing anything that is income tax related.

8. You should never hesitate to take your money when a disaster occurs. Survival is paramount. You can always recover and make a comeback, which would include putting the money back.

9. If you have an equity line or second trust deed and can lower the total interest paid between your first mortgage and this loan, or if you can shorten the amortization of the first mortgage by combining both loans, I wouldn't hesitate at all.

The aforementioned 9 items are not the only ones that exist. In an effort to get the message out, I have picked the areas that most people are concerned with.

And now a brief discussion on the gray area. Many people use their equity for investments of all kinds: real estate, stock market, insurance and annuities, their own business, etc. I feel that if you have the knowledge and sophistication, the temperament to ride out the highs and lows, and the youth to have enough time to make up any losses that could come from your actions, then go for it.

I believe that most homeowners are best served by eventually paying their loan off and having a house that is free and clear that would be the cornerstone, as a minimum, of their retirement. Life is not perfect for any of us, and having a house with equity is one of the best things anyone can have. It is always your decision on how to spend or not spend that equity so it is important to keep your financial knowledge current. If you understand how your income flows and how your outlays affect the bottom line, you should have a good financial life. Do not abdicate the final decision on what to do or when to act to anyone. Empower yourself by ruling your own kingdom.