Ask Paula: Feeling FOMO About Your Home Equity? Here's What to Do

0:00Joe, is your house paid in cash? Do you still have a mortgage on it? What's your deal? We have a mortgage, but it's such a low, low, low interest rate. Interest rates were through the floor. So it's two and three quarters. Nice. Do you have a lot of equity in your home? For an interest rate that was that low, we borrowed more. But the answer is a fair amount. Why do you ask, Paula? Well, I'm asking because the first question that we're going to be addressing today is from a woman who has a lot of home equity and doesn't like the fact that it's just sitting there not making any money. So we're going to answer that plus several more questions.

0:39I thought you were just crying. I know, right? Welcome to the Afford Anything podcast, the show that understands you can afford anything but not everything. Every choice that you make carries a tradeoff, which means the equity that you hold in your home is wealth on your balance sheet that you're not spending elsewhere. So what are the tradeoffs that you're willing to make and how do you execute on those decisions? That is a lifetime practice and that's what this podcast is here to explore and facilitate. I'm Paula Pant. I am the host of this podcast. And every other week, my buddy, Joe Salcihai, the former financial planner, joins me to help answer questions.

1:16What's up, Joe? Well, I'm here. I'm reporting for duty and I'm excited. Fantastic. Let's just dive right in. Our first question comes from Lindy. Hi, Paula. Hi, Joe. I appreciate all your hard work. My question is, I've got a rental house with about$300 ,000 in equity just sitting there and I feel like I'm missing out. I'm just frozen. I'm sitting on the sidelines. I've done fix and flips before, but I'm not excited about buying houses right now. but I feel like I'm missing out on opportunities with this money just sitting there. Is there any ideas that you guys have where I can put this money where it's still building assets or ideally creating a little bit of cash flow or is the best option to just like keep letting it sit there?

2:08Thank you so much. Lindy, that's a great question. And I think that your question is something that a lot of homeowners are feeling right now. If you purchased your home a few years ago, you may have a lot of accumulated equity. Like, Lindy, you've got$300 ,000. And that is, as you rightly point out, wealth that is on your balance sheet, but it isn't overtly making any money. It is in the sense that your equity will rise at the rate of general market appreciation. But beyond that, there is this sense, this FOMO that comes from thinking, wait a minute, I could pull that money out and use it to do something else.

2:50But should I? You think about Paula, it's even worse because this is not her primary residence where I could see that, but being a little conservative. I think it's also for Lindy, the fact that it's in an investment property. And so the investment property is only going up to your point at the rate of appreciation. And you know what I mean? So if it's an investment that's sitting there in something super conservative, it's even worse than if it's your primary residence. Right. But then the decision as to whether or not you should pull that money out comes down to really two things. One is the level of risk that you're willing to take.

3:26And the other is the arbitrage. And so we'll start with the risk. Lindy, I'm saying this not for you, but just for all people who are listening. If you have a particular property and you don't want to risk losing that property, maybe you have a particular property that has a strong emotional significance for you. So, for example, maybe you have a property that's technically a rental property. You know, you're not living in it. You're renting it out. But it was your grandma's house. Right. And it has a lot of emotional significance. And you don't want to risk the possibility of losing it. then I would say, you know, never, never put up for collateral something that you're willing to lose.

4:05And when you borrow against a home, when you borrow against the equity in a home, you are putting that home up for collateral, you are securitizing debt with that home. And so if there's a particular property that has that for emotional reasons, you would never want to lose, then don't risk it. But Lindy, in your case, it sounds like that's not the deal with this property. So then it becomes very much an arbitrage decision. If you were to borrow against that equity right now, you would be paying a pretty high interest rate for the sake of borrowing against that equity. So is there an investment that you could undertake that would have a high enough return?

4:44There would be a big enough spread to justify taking out such a high interest rate. I don't know how many opportunities there are that would give you a big enough spread. I think it's so difficult. You look at the usual opportunities, Paul, that you tell people to start off with. And because of the high interest rate, you got to land where Lindy is. I mean, when I go through what seems like just in general what a good use of that money would be, it's my least favorite option. One of my least favorite options in real estate, which is a flip. But a flip is like buying a job. You know, I mean, you're going to be working full time quickly because you've got to flip that house fast if you're going to make the money work.

5:32So to get that working in a higher interest rate environment, a flip becomes your best friend. But there's all the negatives around that. So I'm reticent to tell Lindy, yeah, go to go take that money out and use it to flip a different yuck. I mean, and not yuck for everybody. You know what I mean? Not yuck for everybody because there's a certain investor that really likes that. It is a full-time job for them and they enjoy it and that's great. But I can't, you know, you can't paint that broad stroke. You know, in Lindy's case, I think flipping could be a good idea because she's done fix and flips before.

6:06So she has the experience. She knows what goes into all the work and the costs that go into doing a fix and flip. And the need to do it fast. Right, exactly. I think a flip would be probably the use. It would be one of two uses of that money that I can think of. Well, one of three, actually, that I can think of that might have a high enough spread. But I say that for Lindy only because she has experience in the past. And she would have to know going into it that this is going to be, as you say, Joe, a full time job. So that's one of three use cases. The second would be on the subject of a full-time job, if she runs some type of a business and if that business needs money for not for day-to-day operational expenses, I'm a proponent that you shouldn't borrow to cover your ongoing operational costs.

6:58But if that business needs to borrow in order to buy some capex, for example, that could really help it expand. Okay, I can see a case there because any business that you are running as a full-time enterprise, right, that can yield some pretty significant returns. That would be a second use case. Now, the third case would be if she were to use this money to buy a rental property. And if she were to do that, this is different than simply taking out another mortgage. Because if she were to do that, she would be still paying her current mortgage on this particular property. But she would also then have a second loan on this property where she's borrowing even more.

7:40So she's stacking interest there. That makes this very different than somebody who is brand new to rental property investing. They're buying a property fresh for the first time and they're getting just one loan on one house, right? Taking out two loans and subjecting your first rental to a bunch of risk because you want that second one to work out, you're stacking the dominoes in a way that you're not when you're just taking out a loan fresh. That's the reason why borrowing against this property to buy another rental is, for her, it's going to be very different than if she were to just go to a bank and take out a fresh loan for a rental.

8:24Those are different risk profiles, different loan scenarios. One of my favorite quotes in investing, Paula, and there's a bunch of them out there, but this one I particularly like, and I'll apologize people that aren't sports fans because it's a baseball reference, but Warren Buffett said that in investing, there's no such thing as a called strike. And in baseball, what happens is if the pitcher throws the pitch, people don't know baseball and you don't swing, it can be really bad if you don't swing, right? Because they will call it a strike. The ball goes right down the middle and you don't swing, they will make it really bad for you.

9:00So you got to swing the bat. What Warren Buffett's alluding to is you don't have to do anything that is not in your best interest. And here's what I like. You and I don't like to play the crystal ball game. I definitely don't like to predict the future, but I can predict this Paula, because I know, I know these things to be true. I know number one, that people have adjustable rate mortgages. And I do know that some of those interest rates are at a low mortgage like mine. Now mine's a fixed rate loan, right? That it's a very low interest There are people with adjustable rate mortgages that rolled the dice and they are sitting on these loans that in the next few years are going to have to be are going to have to be redone.

9:41Those loans are going to be redone at higher rates. I also know there are constantly people doing stupid things like mortgaging themselves to the hilt. So I think like a lot of people think that there may be opportunity. I don't know if it's going to be a lot of opportunities or only a few opportunities, but I do know that there should be some fairly juicy ones coming where you have motivated sellers who just got to get out of this property before the bank takes it back. I think there's going to be some of that coming down the road. If that is true, and I don't think I'm looking really into the crystal ball as much as I am just thinking through, you used the word dominoes earlier, of what happens when interest rates go up.

10:22I like having this ready for a potential deal that does make sense. I think what Lindy's got to do first is figure out what the parameters are of what actually makes sense for her. What does that deal look like that makes sense and do that little bit of math so that when it approaches and it actually happens and appears on her radar, she can then move very quickly. I don't mind having this sitting waiting for a better deal. I feel like sometimes we try to create deals where there are none because of our, I don't know if it's FOMO or what. Right. Or we, well, we try to deploy cash as quickly as we can because we don't like cash sitting on the sidelines.

11:00But in times of opportunity, those who are sitting on cash are the ones who are able to take advantage of that opportunity. You know, Lindy, a way to reframe it rather than thinking, hey, I've got this equity and it's just sitting there, not making any money other than market appreciation on the property. The reframe of that is, hey, I have this like bucket of opportunity, right? And I don't have to do anything with it. I can let it sit there. I can wait for as long as it takes. And then when a great opportunity appears, if the opportunity is so good, I can then use it. So fundamentally that reframe shuffles, I don't want to say cause and effect, but it shuffles the first step and the second, right?

11:48Rather than I have money, therefore I should deploy it. Take that off the table. Instead, it's if I find a great opportunity, then I know that I have a resource I can tap. But if I don't find a great opportunity, then I don't have to tap that resource. I can let that resource continue to rise at the rate of market appreciation. I love that because what it also alludes to is We need to, we being Lindy, I won't be in on that discussion most probably, but she needs to define for herself what great opportunity means. What does that actually mean? So again, beginning with the end in mind, what rate of return does she need to reach her end goal, her end game, whatever that goal is?

12:30And then that gives her a structure in which to decide that this truly is a great opportunity for me. Because an opportunity for you, Paula, that's great, maybe something completely different for me. Right, right. And, you know, the fact that she has mentioned her history with fix and flips in the past makes me wonder if for Lindy, perhaps the opportunity might come in the form of finding a dilapidated property in a great neighborhood, right? Find the worst house on the block. And, you know, if she has the connections, if she has the experience of flipping, then perhaps she could do a flip. And that's an example of great for her, not great for me.

13:10Right, exactly, exactly. The other good thing about using this money to do a flip is that if she were to take out, let's say, a HELOC on this, she would only need to be borrowing against that equity for a very short period of time. Unlike buying a rental property where you've got a long-term mortgage now, if she took out a HELOC, she could use it for six months, pay it back. And if she did that once a year, you know, one flip a year, it's a decent use of that capital. But, Lindy, I think the thinking framework isn't, I have money, therefore I should spend it. It's, I search for opportunity and know that I'm capable of capitalizing on that opportunity, if it appears.

13:52You allude to something tactical there too, Paula, which is, you know, we talked about being able to move quickly when the right deal appears, making sure she has that HELOC ready to go. Like she doesn't want to have to take that out later. If she knows that this money is money she's going to want to deploy, there might be a fee every year to keep the HELOC open and not use it. But certainly for somebody like her who's waiting to deploy it, I would call that a small cost of insurance to be able to write a very quick check to get that stuff moving versus I see an opportunity. I go to my bank. You know how long a bank can take.

14:29I mean, that can drive you crazy. So I definitely prefer to get that open now and have it ready to go. But more broadly, Joe, when you were a financial planner, when people would come to you, I want to take this conversation away from real estate and kind of open this up. When people would come to you and say, hey, I have a bunch of cash that is or I have a bunch of I have assets that are relatively illiquid, but I don't feel as though they're performing as well as they otherwise could be. And I want to make better use of them or I'm feeling FOMO at the fact that I'm not making better use of them.

15:06What would be your general approach to that? So the general approach starts with we need to get away from phrasing like not working as well as it could be because that implies that there is a perfect way for those assets to be used. And if we go to what is the perfect use of an asset, we know what the goal is that we're shooting for. We're investing it into an investment that shares a propensity for winning with that timeline. Meaning if it's over 15 years, stocks and real estate are fantastic. If it's a one-year goal, then generally, not talking about flipping, which is much more of a job, but more of a passive investment is going to be something, you know, a savings account, a money market is a much better place.

15:52A CD is a better place where you have a propensity of winning. I start with that. But then I also start with a bias toward behavior versus statistics. So let me explain that. Statistically, having a low interest rate mortgage like I have now is a winning position because I can do all kinds of fun arbitrage tricks, right? I can pay a little bit on that mortgage every month and then I can invest my money elsewhere. That's the game that I'm playing. Generally, I know though, Paula, I try not to play that game. That rate was just too low for me to not play. A recent study showed that the average retiree is happier if they don't have a mortgage.

16:38And people are generally happier if they don't have debt. So my bias is against debt, not because I won't play the arbitrage game, but because generally people are happier when they don't have it. So if that's the case, I will try to stay away from debt and debt instruments, if at all possible. And I think there's a lot to be said for tearing away from the framework of this money could be working harder, which is it's almost as though what you learn as a beginner in the world of personal finance is at odds with what you need to embrace when you're a bit more intermediate or advanced. As a beginner, when people are first coming to the world of personal finance, they've never thought of the notion that your money could be working for you.

17:23And so teaching people, hey, you don't just have to trade your own time for money. Your money can also make money. That basic foundational concept is great for beginners. But once you're a bit more advanced in the world of personal finance, you then almost have to not unlearn that, but put some additional nuance on that. because it isn't the case that if some is good, more is better. It's more the case that you don't want to take on more risk than you have to in order to get the returns that you are shooting for in order to live the life that you want to live. So, you know, how much risk do you need to take?

18:07How much leverage, if any, do you want to take on? how much of your current success do you want to put up as collateral for the sake of reaching that next tier? At a certain point, you might say, you know what? The success that I have already achieved, I'm good with it or I'm good with slow rolling it from here on out. And I don't want to put up what I've already built as collateral in order to get to that next tier. That's interesting. This is a little scary to say, but you sound exactly like Kevin O 'Leary from Shark Tank, who calls himself Mr. Wonderful. He was talking about, Paula, and he used some pretty wild terms.

18:49He talked about how, well, you need a cushion of$5 million. Now, that's where he starts. But hear this for what it really is. Make sure that that is secure. And after that, then it's very easy to take money out and deploy it into crazy things that are opportunities that really can spur you ahead because you know you're going to be okay. So if we back away from his$5 million mark, what is he saying? He's saying really what you're saying, which is have this money that is toward your goals to go where you want to go. And then beyond that, what do I want to do? What creative stuff can I do? Right.

19:26Essentially build the base, secure the foundation, don't risk the foundation. and then anything above and beyond that foundation, that is subject to risk, but not the foundation itself. So, Lindy, I hope that gives you some additional context for how you should think through, A, whether or not you want to borrow against this equity, and B, if so, what type of opportunities would be worthwhile? So thank you for the question, Lindy. We'll come back to this episode after this word from our sponsors. You know, when you're a kid, you dream about being an astronaut or working with wildlife or all these cool things.

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23:56Our next question comes from Katie. Hi, Paula and Joe. My name is Katie, and I'm a longtime listener and first-time caller. Thank you so much for your work. My spouse and I have learned a ton over the years because of Afford Anything. My question is about accepting Section 8 housing vouchers for a rental property. Specifically, what should my spouse and I be thinking about when considering participating as a landlord in this program? To provide some context, my spouse and I are originally from the U.S., but now live and work overseas with employer-provided housing at no cost to us. We currently don't own any property in the U.S., but plan to retire in my home state in about 18 years.

24:40We want to buy a home, rent it out while we live abroad, and likely live in it once we retire. We're also concerned about the impact redlining has had on the city we plan to buy in, and want to ensure we provide a fair housing opportunity to potential renters. From my research, it seems like one way to do this is through Section 8, but many landlords don't seem to opt into the program. Any insight into pursuing Section 8 or similar programs is appreciated. Thank you and have a great day. Katie, I love the question. So first of all, congratulations on having such a clear plan and on caring so much about your community and wanting to make sure that you are doing what is best, not only for yourself, but also for your community.

25:29So let's talk through both of these concepts. And I'm going to talk about each one separately because the link between, you know, within your question, you ask if there is an established link between the problem of redlining and the potential solution of Section 8. But let's talk about each idea separately. So first of all, I know many landlords who participate in Section 8. I even myself considered putting one of my properties, one specific property on Section 8. The advantages, as I'm sure you already know, are that you have a certain percentage of your rent that is guaranteed, right? And so you know that you're able to count on that.

26:15The disadvantages are that you have to follow the Section 8 guidelines in terms of exactly how much you can charge. you have to follow the Section 8 inspector on precisely the quality and the repairs and maintenance of the property. And on the surface, those don't sound like big deals. But I've heard stories from investors where, for example, they might have a very, very old home with historic windows, but one of those windows has like a tiny little chip in it. The Section 8 inspector says, well, you can't have a cracked window, so you need to take out these hundred-year-old wood historic windows and put in, right?

27:00Yeah. So things like that, where the code is not written in a way that takes into account the nuance or the character of a particular home, you know, and then you're like taking out these historic wood windows that are on a pulley system, right? Like that, it removes the character from the home. It removes the character. It actually makes the home and by extension, the neighborhood a little bit worse, but this is what the program requires me to do. So little things like that, I've heard landlords complain about. The bigger thing administratively is that every I needs to be dotted, every T needs to be crossed.