Home Equity Management

Using the equity in your home to generate wealth has been a  popular topic within mortgage circles the past few years. Spurred by the popular book "Missed Fortune 101" by Douglas Andrew, many mortgage professionals are advising their clients on how to best manage the equity in their homes.

This strategy can yield results for the right person within the right context. It can even be a way to funding your retirement or achieving other long term financial goals.

The Concept of Equity Management

The main concept behind home equity management is that you invest the "cash" that is trapped in your home to generate more wealth. If done correctly, this cash should generate enough returns wherein your mortgage debt is easily payable at any given moment. This renders your debt "meaningless" and frees you to pursue your investments more aggressively.

The underlying perspective is that your home will appreciate regardless of whether you payoff the mortgage or not. Hence, there is little monetary reason to pay off the debt. Rather, it is better to utilize that cash towards a more profitable investment. It basically comes down to whether you would rather invest in a zero yield bond (which is your home) or invest in a more profitable venture (the S&P 500 has posted an average 10.5% per year gain over the past 70 years).

Two Methods

There are two ways to utilize the equity in your home. The first is to pull out the equity you already have in your home and invest it in a higher return investment. This strategy works due to arbitrage - the difference in the return on money and the cost of money - the exact idea banks use to make money on deposits. Some investors are more aggressive than others in using this method, but it is generally a good idea to keep at least 6-12 months of the fully amortized payment in a readily accessible reserve account, to protect against fluctuations in the market.

The second less aggressive way to use the equity in your home is to obtain an interest only mortgage. You then invest the amount you would have paid in principal. I say this is less aggressive because you don't have the risk a large sum at a single instance. Some investors use negative amortization loans, or "Option ARM" loans in this way by paying the minimum payment on their mortgage and investing the difference, including principal and interest, into a higher-yield vehicle.

There are situations where both methods can be employed to achieve an even greater return on your investment.

Where do I start?

As I mentioned before, this strategy is not for everyone.This strategy is successful only if you are already disciplined in your finances and have a history of making sound financial decisions. This does not mean that you can not learn to use this strategy effectively to your advantage.

Certain real estate companies help their clients in making the right decisions in these kinds of investments. Proper equity management is a key element of financial responsibility, but it should not be attempted without professional help.