If you own a home, you probably know what home equity is. It’s the difference between the value of your home and the amount you owe on your mortgage. But do you know what dead equity is?
Some investors would consider untapped home equity in a low-interest environment dead equity and a lost opportunity.
In real estate, dead equity refers to the money you have tied up in your home that you’re not using to increase your investments. In other words, you might have $100,000 of equity in your home, but how is that making you any money? Because you have a large asset not earning any interest, some would consider it “dead."
When interest rates are low, you can get a good rate on a loan. There are many ways to do this — home equity loans, home equity lines of credit, reverse mortgages — but the result is the same: You borrow money against an asset you own (the equity in your home).
For example, say you borrow on the equity in your home. If interest rates for home equity loans are low, say 4.5 percent, some advisors might tell you it’s smart to borrow against that equity and invest in stocks or other investments that could yield 6 or 8 percent returns. That way, although you’re borrowing money, you’re making up the difference between the interest rate and your yield. In this case, that’s 1.5 or even 3.5 percent.
Whether you try something like this depends on your tolerance for risk. It might be very exciting to think about borrowing money at 4.5 percent to earn 8 percent with the proceeds, but remember that no investment is a sure thing.
For example, the stock market fluctuates, so while you might borrow on your home to invest in a bull market, there’s the possibility you end up taking out a loan to invest in a bear market — putting you in a deep hole. Is this a risk you can afford to take?
Another question is how much savings and how many income streams you have to carry you through unexpected financial troubles like a job loss, significant medical bills or unexpected home repairs? If faced with any of these, would you still be able to make the additional loan payments? If not, you might be putting your home at risk.
As with any investment, it’s best to start with a full understanding of the potential risks as well as the benefits. Use the U.S. Bank home equity loan calculator to compare rates and payments across a variety of home equity options. But after you calculate your potential for a home equity loan, think carefully before you sign on the dotted line.
Learn more ways to leverage your home’s equity.