If you've ever bought a home, chances are you know about equity. If you bought a home more than six years ago, then you definitely know about home equity because you've probably watched it rise and rise. Most homeowners have seen a flood of home equity offers come their way in the past few years, with whopping amounts apparently available to homeowners. Borrow so many thousands of dollars, go on that vacation, renovate your home, it's so easy! Certainly, your home is probably your biggest asset, and for most people the biggest investment they'll ever make. As the offers for home equity lines of credit state, the value of your house may have risen substantially over the years, and you may be sitting on a lot of money, should you decide to sell. For this reason, many homeowners these days have come to think of their houses as a means of financing the big purchases in their lives. More and more homeowners borrow against the supposed higher value of their homes, taking on more debt according to the rising prices in the booming real estate market. Houses have become secondary bank accounts, from which borrowers withdraw cash for all sorts of purchases.
On the other hand, some homeowners consider the increased equity not bank account, but rather a form of retirement planning. "Hold onto this thing, and we'll be rich in our old age", they seem to think. Although this strategy seems more careful, since the homeowners are planning for retirement rather than spending the equity in their homes, both groups are making bad investment choices. As we have seen recently in the news, the real estate market is highly volatile and things can go downhill very quickly, just as they went uphill rather quickly. Your equity can disappear almost overnight, as demand for housing dries up, supply surges, or risky loans re-adjust after a few years and banks start foreclosing, all of which send housing prices falling. Equity is perceived value, just as the price of your home is perceived value as well. It depends on the market, and the market is fickle, if not totally unpredictable. Yes, we should have seen this coming, considering the state of the subprime mortgage market, and in view of history of real estate markets.
Over the years, even if you sell your home for so much more than you paid, you've still incurred costs along the way. These costs would include upkeep, taxes, condo fees, perhaps. People have studied this, and they find that the cost of owning the home turns out in the end to be more than the money homeowners make when selling. A house is just not the type of investment people think it is. It's your home. It's your shelter from the world, it's your comfort at the end of a long day. Isn't that enough? Let the professional investors try and make money off of real estate. They have more cash than the average person, for these types of investments. They also have insiders' knowledge of how to buy under-priced homes and how to flip them at the right moment. Don't play with your life savings (your home) by treating home ownership as a get-rich scheme.
Studies have also shown that over the years, a house rarely makes as much money as the returns you'd get in the stock market or other types of investments. The cycle for upswings and downturns in real estate can be far too long for the average person to suffer through. For example, consider a decade-long downswing in home prices and see how your investment feels after that. Or, consider a quarter century of measely 4% returns on real estate. Both of these things really happened in various parts of the country.
The moral of the story is, don't put too much of your net worth into your primary residence, especially if you're near retirement. A downswing like the one described above can be devastating for your finances. Stay modest with your borrowing, keep your costs down and try to avoid that equity line of credit, and diversify your investments.
