The Truth About Investing with Your Home Equity

One of the many definitions of maturity is the ability to delay pleasure for something greater in the future. This is not a quality that most Americans seem to have anymore. People want everything now and think good old fashioned hard work is for suckers. People give into all sorts of crazy investment schemes which are extremely high in fees and low in rates of return, such as investing in life insurance products and overnight cable show's real estate programs. In reality, these things just do not work. Another recent fad is for the 'savvy' investor is to invest in the equity in his or her home.

Here's how it is supposed to work. Let's say that John has a home worth $100,000, and has $75,000 in equity in it. John decides that he thinks he needs that $75,000 in equity in order to invest in some hot new company and will make a lot of money on that $75,000 and after he is done investing he will be able to return that $75,000 in the house and keep whatever money he made from the investment. So John goes down to his local bank or credit union, and signs up for a home equity line of credit or a second mortgage. These loans are simply a secured line of credit with your home as collateral. John gets his $75,000 and invests it in the stock market, because the stock market has averaged 12% since inception, whereas his home mortgage is only 6%, so he'll be making 6% off the top, for free!

Sounds great in theory, right? Well, that's the only place it sounds great. There are so many issues with this investment scheme that it very quickly becomes an undesirable road to wealth. First, let's mathematically look and see if it's -really- worth investing, getting 6% off the top might seem attractive. For our friend John that would be seemingly be $4500 a year after he pays the interest on his loan. Will it really end up being that much? No, Of course not. First, John has to pay taxes on that money. Capital gains taxes in the United States are currently 15%. This means John would only make $3100 a year instead of $4500.