Conventional wisdom tells us that the quicker you pay off your mortgage, the better off you are. Lots of people want to own their homes outright as soon as they can. It’s true that if you pay off your mortgage sooner, you end up paying less interest, but there’s a better alternative to owning your house outright. Read on to learn the risk of homeownership and the benefits of diversification.
Is your home your most significant asset? For most people, it is
Research shows that 61% of homeowners own at least 50% of the equity in their homes. Let’s imagine you own a home worth $500,000, and you have a mortgage for half of that and hold $250,000 worth of the equity. With a mortgage rate of 3%, your principal plus interest payment is $1,054 per month. Like the average American, you will have about $3,500 in savings and about $22,217 in your 401k. This means that your total net worth is $275,717. Nearly 91% of your wealth is tied up in your home.
Do you have more money in your home than in your 401k and your savings account?
Given that the average homeowner owns $194,000 of equity in their home but has only $22,217 in their 401k and $3,500 in savings (third quarter 2020), their home is the biggest asset they have. In some ways, this makes sense because everyone needs a roof over their head. Yet, there is also risk inherent in having so much of one’s net worth tied up in a single asset.
The benefits of diversification and risk management
In finance, diversification is a widely used method for reducing risk. The idea is simple. When you have all of your wealth tied up in a single asset, your entire net worth reduces if that asset loses value. If you have a diversified portfolio with your wealth invested in various assets, the risk decreases. If one of the assets loses value, the rest of the portfolio remains intact. A properly balanced portfolio should be designed so that, at any given time, if one set of assets loses value, another group of investments may rise in value to offset losses.
Do you have a balanced real estate portfolio to mitigate your risk?
Most sophisticated investors have a well-balanced and diversified portfolio to limit their exposure to market fluctuations and reduce their risk. Unfortunately, however, the average American homeowner has no such protection. With much of their wealth tied up in a single asset—their home—they are exposed to significant risk.
The risk to your homeownership wealth when the housing market crashes?
The housing market has, from time to time, suffered precipitous dips in value. Over recent years, house prices have increased steadily, but there is always a risk that a housing downturn could come. This is why it is good to diversify. So, is it a good idea to have so much of your wealth tied up in your home? The answer has to be no. It is best to tap some of that value and reinvest it in a more diversified way.
The problem, however, is that residential real estate is a particularly illiquid asset. If you, the homeowner, want to take some of the wealth out of your home and reinvest it in other assets, it is difficult. Beyond using debt to borrow against the house, you may have little opportunity to get liquidity out of your home at a reasonable price. One widely available option to take liquidity out of your home is by using an equity line of credit (HELOC), equity loan, or refinancing your home.
Refinancing or Equity Loans (HELOCs) as a strategy for diversification is even riskier
However, borrowing against your home equity to diversify is not the solution because it exposes you to even more significant risks. If the value of your home decreases, you will still owe the entire amount you borrowed, but the underlying asset is worth less. You are, therefore, now underwater in your home. Underwater means that the debt secured by your home is more than your home is worth. So, if you want to sell your home, you will need to bring additional money to the closing to pay off your mortgage because the sale proceeds won’t cover what you owe.
Paying off your mortgage is a good idea in some ways but also adds risk
To ensure their home is not at risk and avoid additional interest payments, homeowners feel that they need to pay off their mortgages as quickly as possible. For example, on a 30-year loan at 3%, you would pay $129,443 in interest over the life of the loan. You save a lot of money in interest if you pay off the loan sooner, so it is a good idea to pay off your mortgage as soon as you can. But if you pay off your mortgage entirely, you own the home outright and have a lot of your financial eggs in one basket, thus opening yourself up to the risk discussed earlier.
Invown your home – a new way to diversify without debt
But what if there was a way to get money from your home equity while saving money on interest, avoiding the risk of being underwater, and at the same time diversifying your wealth?
There is a way.
One way of doing this is by selling a portion of your home to an investor. Because you are selling equity rather than taking on debt, you get cash. You are protected against the possibility of being underwater—if the home decreases in value, the investor’s position in the home also decreases. Furthermore, you do not have to pay interest on the money you get from the investor. As the homeowner, you can then use the proceeds of the investment to invest in other assets, thereby diversifying your wealth and reducing your risk.
Shared equity—the solution to diversifying and de-risking your illiquid assets
This strategy is called shared equity, and it has only recently become available to the average homeowner. Some companies offer it, and we at Invown are one of them. But, while other shared equity programs provide cash at a rate dictated by the investor, at Invown, because we are a platform that brings investors and homeowners together, you, the homeowner, dictate the investment terms. The investor can either take it or leave it.
Go from Homeowner to Invowner
Also, because Invown is a two-sided platform, if you, the homeowner, decide that you want to sell equity to investors and reinvest the proceeds in other residential properties, you can do so on Invown. The name Invown combines the words “invest” and “own.” When you sell part of your equity to reinvest to pay off high-interest debt, to diversify and de-risk your holdings, you, the homeowner, become an “Invowner.”
Become an early adopter to join this new and exciting trend in real estate owning and investing.