Over the past couple of years I have discovered a growing trend that a number of people seem to be doing. It goes something like this, “We only want to invest AFTER we have finished paying off our house.” Fair enough. I can see that some people want the security that comes with owning your own home outright without a loan.
What I don’t understand is what some people do next. “OMG Brad isn’t it so fantastic that we have saved every penny for the last 10 years so we can now say we own our $500K house outright without a loan?” “Certainly is Jenny, such a relief that we don’t have a loan, I think it’s time we looked into investing outside our Super to build a nest egg to retire on.”
They start to talk to friends about investing and of course because they live in Australia the topic of investing quickly turns to real estate and how everyone knows someone who bought a house that doubled in 7 years blah blah blah.
Intrigued, they do a bit of research and ask family or friends how they can get started. They eventually book an appointment in with a broker to assess their borrowing capacity and what’s involved with getting a loan for an investment property. The broker educates them that they would have to save X amount of money to put down as a deposit OR they could use equity in their home and could get a loan straight away. “Wow, you mean we wouldn’t have to wait and save a deposit?”
“Yes, that’s right, just pull out some equity in your house and use it as collateral for your investment property.” Brad and Jen are amazed that they don’t need to save anything and can get started right away. The spur of the moment excitement causes them to go through with the process and they are now the proud owners of an investment property after pulling out $80K of equity from their home. A few years pass and they get the property revalued. To their amazement, their investment property has risen in value by over $70K. They are so excited that they could make so much money just by owning the house that they want to have another. They have plenty of equity their broker explains so this shouldn’t be an issue. After 3 or 4 properties they start to run out of equity as they approached 80% LVR for their own home.
[pullquote align=”full” cite=”” link=”” color=”#ffa500″ class=”” size=””]My problem is that if you are intending to use the equity in your house you might as well not pay it off to begin with[/pullquote]
When I hear people utilise this strategy I cringe. I mean what’s the point of paying off your own home just to withdraw the equity to invest with? You’re just wasting time doing this. As I’ve mentioned in a previous post, the earlier you start investing, the better. I have no problem with people using equity from another investment as I do it myself. And I have no issues with people wanting to pay off their home.
My problem is that if you are intending to use the equity in your house you might as well not pay it off to begin with. All you’re doing is delaying the process. The 10 years that your dollars have been locked away in your house have essentially been wasted because there’s only two ways to make money in real estate, rental income and capital appreciation and you’re doing neither when you buy a home (unless you sell).
A home should be bought and paid off for security and peace of mind. When you withdraw equity from it you are no longer debt free and your home could be repossessed (worst case scenario).
Either invest before you start paying off a home, or, if you already have paid off your home please think back to why you wanted to pay it off in the first place and realise that when you withdraw equity from it, you no longer own it debt free. As tough as it sounds you need to start building your portfolio from scratch BUT it should be a lot easier to save for those who have paid off their home compared to most people since you have don’t have any house repayments to make.
Try to work out at the start what you want to do. Do you want to own your home outright, or do you want to start investing early. Pick one and then go after it! Do you know anyone that has paid off their home only to withdraw equity from it to invest with?
*For those who have discovered investing later in life please don’t take the heading personally. This article is more aimed at the people who actually plan to pay off their home only to withdraw from it. If you discover investing after you have paid off your home and then decide to invest your equity, that is completely different and I would say go for it!