Most real estate investors face the following challenge: they are real estate rich but cash poor. Meaning, they have purchased their primary residence, second home, or investment property and have enjoyed rapid appreciation beyond their expectation. This may look like a good idea on paper. However, as a real estate investor, is it the wisest choice to have thousands (or millions) of dollars of equity doing absolutely nothing for you?
Keep reading for 4 great myths that prevent property owners from properly managing the equity in their real estate:
Risk: Real estate throughout the nation has enjoyed rapid appreciation over the last few years, thanks to historically low mortgage rates. However, what few real estate investors realize is there are a number of risks associated with excess equity accumulation:
Reward: Implementing a strategy to utilize and maximize the real estate equity will help the real estate investor create a diversified wealth accumulation program and potentially insulate the investor against these risk and potentially, many more.
2. Myth: Making additional principal payments is wise.
Risk: In many situations, it is wise for a real estate investor to make additional principal payments towards their mortgage debt, to accelerate the original loan payoff. However, as we learned in step 1, essentially, even though we may be shaving years off of the original term of the mortgage, we are now adding to our risk by increasing our real estate stake. Again, if additional funds are directed towards the mortgage and one of the many risks we mentioned occurred, we have now placed more of our assets into an illiquid investment which could lose value.
Reward: The real estate investor should establish a separate investment account. Instead of paying the additional mortgage payment to the lender, the borrower should invest this payment into a safe and conservative tax deferred investment that earns more than the mortgage interest. By doing so, they will be in control of the funds, maintain their interest tax deductibility and therefore, the borrower will be able to decide when and if they want to pay off the home.
3. Myth: I should pay off my mortgage as quickly as possible.
Risk: Mortgage interest savings vs. the benefits of mortgage deductibility and diversification is the looming question real estate investors struggle with. One must carefully evaluate the true cost of a mortgage after factoring the interest tax deduction. For those investors in a high tax bracket, this is especially important.
Reward: The investor should focus on accumulating wealth outside of the real estate, then at some point use this asset to pay off the mortgage or purchase additional investments.
4. Myth: The more equity I have in my real estate, the greater the security.
Risk: This is one of the most common misconceptions of the real estate investor. Psychologically, it may feel good to know your real estate has substantial equity. However, as previously discussed, there are inherit risk associated with this thinking.
Reward: As mentioned above, it may be comforting to know you have built up high equity in your investment property. This can be a boost to your self-esteem and your personal wealth or credit.
The Bottom Line: There are many different avenues to wealth accumulation. Real estate investing is a great strategy to building your wealth, so long as you consider the risks and rewards in a balanced way. Always discuss major investment decisions with a trusted advisor and family member.
Jon Sanchez is a registered representative offering securities and advisory services through Independent Financial Group, LLC (IFG), a registered broker-dealer and investment advisor. Member FINRA/SIPC. OSJ Branch: 12671 High Bluff Drive Suite 200 San Diego, CA 92130. Sanchez Wealth Management, LLC and IFG are not affiliated entities. CA Insurance Lic. #0772626.