When times are good in real estate there are plenty of reasons to cash-out. But, the cash-out only works to your financial benefit if you’re actually putting real money towards your net worth. Your net worth is the amount of money you have left over when your liabilities (what you owe) are subtracted from your assets (what you own).
Far too often I’ve seen people cash-out of their properties only to a buy bigger and more expensive home with a mortgage twice as large as the previous. That is definitely not considered a cash-out; rather it’s a traditional home upgrade.
Cashing-out in a hot real estate market really only makes sense under three scenarios.
1. Selling an expensive property and using that equity to buy a less expensive property
This effectively means you are scooping out the equity in one property to apply it to another property, but with a lesser mortgage. An example could be selling your $750,000 home with a $300,000 mortgage and buying a home costing $600,000 with a $150,000 mortgage. In that case, you’ve applied the difference between the sale price of the expensive home to the purchase of the new home.
2. You are selling and then renting
When you sell and exit the real estate market completely, all the equity you had in your property is deposited into your bank account in cash. Theoretically, you could invest those dollars through traditional stocks, bonds and funds; growing your investments rather than paying for real estate. Let’s say you benefited heavily from a surging real estate market and had $500,000 in equity from your house sale that you invested at 8 per cent rate of return for 25 years. That money would be grow to $3.4 million in 25 years. Certainly, you would have had to have paid rent for all those years, but 25 years of rent won’t total up to $3.4 million…unless you move into an expensive penthouse.
3. You renovate your existing property rather than sell it
A smart home renovation can add tremendous value to a property especially if it increases square footage and functionality. The two most valuable places to improve are your kitchen and bathrooms. But, home renovations only produce real money when the home is sold. So, you’ll be on the hook to finance these improvements yourself through savings, a second mortgage or a home equity line of credit (HELOC).
Renovations can be a slippery slope where people milk their home dry of its equity to fund poor home improvements. So, be sure that you can afford to float the costs and hire an expert designer and contractor. They’ll help you stick to the areas where you’ll surely see a high return on investment.