Friday, January 26, 2007

Converting 'Dead Equity' To Productivity

A lot of people are proud that they owe nothing on their home . . . or on a piece of investment property. And they should be proud of their hard work!

BUT (you knew it was coming, didn't you) . . . when a home or other property has high or full equity, it is what we call a "dead asset." Put another way, it is wealth that you possess that is not benefiting you. Think about it -- property usually doubles in value every 10 years or so. Say you bought a house for $50,000 and it is now worth $100,000. And when you bought it you put $10,000 down and financed the remaining $40,000. Over the 10 years your mortgage payments built up an additional $15,000 in equity. So you now owe only $25,000 on a home that has appreciated in value due to inflation to approximately $100,000. As a colleague of mine here in Central Ohio, real estate investment guru Furman Tinon, puts it, "inflation pruduces more multi-millionaires than anything else." But this new worth is not benefiting you.

After 10 years you now have $75,000 of net worth in your home ($100,000 current value minus the $25,000 note you still owe from your original note). To put this wealth to use, you go to a lender and refinance. Get a 75% loan against the value of the home, of $75,000. Pay off the $25,000 outstanding loan. You now have $50,000 cash at your disposal -- tax free. You take that amount and put $50,000 down on a $200,000 investment property. That's an instant 25 percent equity in the new property. And since it is an income property, it will be easy to finance. The monthly income (rent) your residents pay you should cover your monthly mortgage on the new property, and you get to exploit numerous tax advantages, such as: deductions for any property improvements you make; depreciation/cost recovery. Plus, if you sell this property in a 1031 tax-deferred exchange after five years, you will not pay any capital gains taxes on this new property's appreciation. You move the equity you have where it will work harder!

No comments: