Accumulated home equity is the single biggest asset for most American households. Growing home equity by making a bigger downpayment, extra mortgage payments and by minimizing home equity borrowing is a time-honored mantra of “good” personal finance management. But is keeping home equity illiquid in the home really a good financial move?

We recently came across this report (really a sales piece) that presents some though-provoking arguments as to why homeowners might be better off separating their equity from the home and converting it to liquid, secure investments. The basic premise of the report (supported by a well-done illustration of two brothers taking different paths) is that a homeowner who follows a strategy of maximizing tax-advantaged mortgage debt - by making minimum downpayment, interest-only payments, maximizing term of loan, etc. - can invest the funds that would have gone toward principal retirement and come out way ahead of a borrower who strives to pay down the mortgage as fast as he can.

Other key assertions include:

• carrying a large mortgage balance places you in a better position vis a vis the lender in the event of foreclosure;
• liquifying home equity protects you in the event of job loss or natural disaster that might make equity inaccessible;
• idle equity locked-up in the home is subject to housing market risk and yields no return - i.e. the value of a home can rise regardless of equity separated from the home;
• having too many eggs in the idle home equity basket equals poor asset diversification;
• the tax deductibility of mortgage interest makes profitable arbitrage opportunities relatively easy to find.

To a large degree, many of the central points in this report rely on the assumption that homeowners following this strategy will behave rationally and systematically - e.g. the net funds made available from a lower monthly mortgage payment will be diligently invested. We suspect many (most?) typical homeowners would find it very difficult or impossible to be so diligent in the long-run. The reason this strategy may work well for the “affluent” homeowner is that they have other resources to rely on. For the average homeowner, home equity is the most cost-effective way to borrow big sums of money - not for investment arbitrage - but for important everyday needs like a new roof or college for the kids.

This website focuses on ideas and tips for tapping home equity (through the HELOC mechanism) in a measured manner for prudent uses. We do not promote the gung-ho withdrawal of equity for investment arbitrage puposes. But regardless of whether you fully agree with the thesis of this report (”homes are designed to house families, not store cash”), the authors (Steve Marshall & Mike Lowe of Bellevue Mutual Mortgage) do make many good points that are worth mulling over. Overall, it is a well-written document worth taking 20 minutes to read.

For months it has largely been assumed that the ongoing housing market corrections would ultimately play out in the consumer spending arena - perhaps even leading to recession. The logic seemed sound: homeowners, grown accustomed to writing a check on the HELOC account to pay for their new cars and vacations, would slowdown spending in the face of both higher interest costs on their HELOC and stagnant equity growth in their homes.

But the Wall Street Journal (10/02/06) now reports that the home equity driven spending apparently is not the lynchpin of consumer behavior it was thought to be:

“A year into the housing market’s slowdown, Americans have yet to snap shut their wallets, defying predictions that the cooling market would have a chilling effect on consumer spending.”

While less money is being extracted from home equity than in the recent past, other factors including rising stock prices, falling fuel prices and good employment figures are helping to fill the void.

The article cites some interesting and positive (if little known) statistics about HELOC spending habits that are worth repeating:

• A recent survey done for Deutsche Bank Securities found that homeowners spent only about 14% of the money they cashed out of their homes - and that didn’t go back into their real estate investments - on consumer goods. The rest was either used to make other investments or to repay debt.
• The overwhelming majority of mortgage debt and home equity loansare held by Americans in the upper half of the income range. The top 10% of wage earners hold 42% of total home-equity credit lines, according to data from the Fed’s 2004 Survey of Consumer Finances. Thise affluent consumers have already racked up sizable gains in the value of their homes in recent years and can most likely afford to weather a modest pullback without cutting back their spending.

Technorati Tags: housing market, HELOC, Deutsche Bank Securities, Survey of Consumer Finances