What is "Dead" Home Equity?

March 6, 2006, Reviewed July 10, 2007, May 1, 2011

"I bought a house two years ago that is now worth 340K, I have a 4.5% fixed-rate mortgage on it for 240K. I am being told that my 100K of equity is "dead", just sitting there doing nothing for me. How can I make my equity work for me? I don’t want to do anything stupid."

"Dead home equity" with its implication of opportunity foregone, is a meaningless concept.

What Is Home Equity?

Home equity is equal to property value less all liens on the house, which in your case comes to 100K. Calling equity "dead" is a distortion of the English language. The fact is that the more equity you have, the better off you are. If you have a car with no car loan, you have dead equity in your car, but no car owner should feel guilty about that. Owning an asset free and clear is an objective to be sought, whether it is a car or a house.

The Argument For Depleting Home Equity

Proponents of the dead equity idea want to sell you the loans that would deplete your equity, and the investments they claim would more than recover it. For example, if you borrow 100K against your home and use it to purchase investments, your home equity is eliminated but it is replaced by an equal amount of assets, so your net worth remains the same. If these assets earn 9% and the 100K mortgage costs only 6.5%, after a year your net worth will be $2500 larger. On the other hand, if these assets only yield 4%, after a year you will be $2500 poorer. Reducing your home equity in order to invest is risky.

There are circumstances where it makes sense. If an investment opportunity comes along in which you have great confidence because it is a project in which you will be personally involved, and it requires money you don’t have, consider borrowing against your home equity. It is a calculated risk that may be worth taking, especially by a younger person who will have an opportunity to recover if the project doesn’t pan out.

The Argument Against Depleting Home Equity

Few homeowners develop their own investment opportunities. Most are persuaded to invest in projects brought to them by those preaching the "dead equity" sermon. I view the risks associated with these investments as unacceptably high for most home owners, and especially for seniors and those who anticipate that they may have financial problems in the future that will cut their income.

If you have a concern about your future ability to make mortgage and other payments, you want to keep your home equity readily available. Think of it as a reserve account you can tap into if you need to. It doesn’t take long to open a home equity line of credit (HELOC) that you can use to keep current on your obligations. WARNING: Don’t try to do this after you become delinquent, then it will be too late.

Assess the Advice-Givers

There are some very nice, sincere people preaching the dead equity message, but their financial interests are not aligned with yours. They make most of their money on the loan transactions that will deplete your equity, and on the investments that will make your fortune. In other words, they get theirs upfront, while your financial fate is decided down the road.

I might reconsider if I could find one who would align his financial interest completely with mine. This would require a) that he provide the mortgage loan at the wholesale price (no broker markup), and remit the full sale commission on the investment to me; and b) He would share the difference between the income earned on the investment and the interest payment on my mortgage, including a loss if the spread became negative.

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