I am sure you are asking yourself, "what the heck is this guy talking about?"  Well, if you have been focusing on paying off your mortgage, you probably have no clue.  Here is what I am talking about.

You may have missed this stat recently released...US 2Q Homeowner's Equity Falls to 13 Year Low.  Surprised?  You shouldn't be.  With all of the recent gains in real estate over the last several years, many homeowners have rushed to cash in some of that equity.  Most, unfortunately, went out and spent it or otherwise failed to receive the benefits of proper utilization of that equity.  With the recent drop in real estate values in many areas across the US, is it any wonder that home equity levels have dropped dramatically?

Some savvy homeowners did the right thing, though.  They took they cash out of their homes and invested it in safe, liquid accounts and are now having that money work for them, instead of disappearing within the walls of their homes.

Let's take a look at how you could have "lost equity", even having a mortgage balance greater than your home's value, and have it working for you.

Let's assume (I know what happens when you do that but let's risk it anyway) that three homeowners had a homes that appraised for $500,000 each 5 years ago and their mortgage balance was $300,000 at that time, each interest only.  Today's appraisal on these same homes (located in South Florida) are now valued at only $350,000.

The first homeowner decided against taking any cash out of their home, instead keeping status quo and refusing to take on added debt.  They were relatively smart as they decided to invest the monthly difference into a safe, liquid account, so they have some savings.

The second homeowner, was like many Americans, went ahead and did an 80% LTV cash out refinance, leaving them with a mortgage amount of $400,000 and $100,000 cash (the maximum allowable for tax purposes normally).  They spent the money on new cars, vacations, or other "wants", leaving them in more debt and now "upside down" in their homes.

The third homeowner decided to take advantage of the appreciation and did an 80% LTV cash out refinance, leaving them with a mortgage of $400,000 and $100,000 cash.  They opted to invest to meet financial goals down the road instead of spending the money now

So, if each homeowner were to sell right now, how well off would they be?  Are any in serious trouble?  Did any actually come out in reasonable shape?

Assuming a 6.00% mortgage and a 6% rate of return on the investment accounts, here is what each homeowner looks like right now...

As you can see, neither Homeowner 1 or 3 are in any real trouble, however, Homeowner 3 actually has part of the "lost equity" working for them as an investment.  Over a longer time period, Homeowner 3 will prove far ahead financially than even Homeowner 1.

Homeowner 2, not unlike many Americans these days, is not so fortunate.  If they have to sell, they will need to borrow $50,000 from somewhere to cover the losses.  If they are unable, they will need to do a "short sale", which will negatively impact their credit rating and ability to obtain a new home, even rent one.

Which homeowner would you like to be?