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How the Affluent Manage Home Equity to Safely and Conservatively Build Wealth
If you had enough money to pay off your mortgage right now, would you? Many people would. In fact, the ‘American Dream’ is to own your own home, and to own it outright, with no mortgage. If the American Dream is so wonderful, how can we explain the fact that thousands of financially successful people, who have more than enough money to pay off their mortgage, refuse to do so. The answer? Most of what we believe about mortgages which we The answer?and Mosthome of whatequity, we believe about mortgages and home equity, learned from our parents and grandparents, weThey learned fromusour iswhich wrong. taught to parents make a and big down grandparents, is wrong. They taught us and payment, get a fixed rate mortgage, to make a big down payment, get a fixed make extra principle payments in order to pay rate mortgage, and make extra principle off your loan as early as you can. Mortgages, payments in order to pay off your loan as they arecan. a necessary evilthey at best. earlysaid, as you Mortgages, said, are a necessary evil at best.
The problem with this rationale is it has become outdated. Therationale rules ofismoney The problem with this it has have become outdated. Thegrandparents, rules of moneywe will changed. Unlike our have changed. our job grandparents, no longer have Unlike the same for 30 years. In we will no longer have the same job for many cases people will switch careers five 30 years. In many cases people will switch orcareers six times. Also, unlike our grandparents, five or six times. Also, unlike our we can no longer on ourdepend company’s grandparents, we depend can no longer pension plan for a secure retirement. on our company’s pension plan for a A recent secure survey retirement. A recent Gallup showed that Gallup 75% ofsurvey workers showed that 75% of workers want to retire want to retire before the age of 60, yet only before thethey age can. of 60, yet only 25% think 25% think they can.
Unlike our grandparents, we will no longer Unlike our grandparents, we will no live in the same home for 30 years. Statistics longer live in the same home for 30 show that the average homeowner lives in years. Statistics show that the average their home for only sevenhome years. homeowner lives in their forAnd onlyunlike our grandparents, we will no longer keep the seven years. And unlike our grandparents, we will no longerforkeep the same mortgage same mortgage 30 years. According to the for 30 years. According to theAssociation, Federal Federal National Mortgage or National Mortgage Association, or Fannie Fannie Mae, the average American mortgage Mae, the average American mortgage lasts 4.2 years. People are refinancing their lasts 4.2 years. People are refinancing homes everyevery 4.2 4.2 years their homes yearstotoimprove improve their interest rate, restructure their debt, remodel their interest rate, restructure their debt, remodel their home, or tomoney pull out their home, or to pull out formoney investing, for investing, or other Given expenses. education or education other expenses. these Given these statistics, it’s difficult to statistics, it’s difficult to understand why understand why so many Americans so many Americans continue to pay a high continue to pay a high interest rate interest premiumrate premium for a 30-year fixed rate mortgage, when they are likely to only use
the first 4.2 years of the mortgage. We can financial planning goal, and in fact how you only conclude theyrate aremortgage, operatingwhen on outdated ultimate handle issuesplanning of homegoal, ownership financial and in may well for a 30-year fixed how you handle issues of home they are likelyfrom to only use thegenerations first 4.2 knowledge previous when factdetermine whether you achieve financial years the mortgage. can than only the 30 year ownership thereofwere few optionsWe other success.”may well determine whether you achieve financial success.” conclude they are operating on outdated fixed mortgage. Wealthy Americans, those knowledge from previous generations with the ability to pay off their mortgage but when there were few options other than Why people fear mortgages, refuse to do understand how to make Why people fear mortgages, the 30 year fixedso,mortgage. Wealthy and whyyou youshouldn’t shouldn’t and why their mortgage for them. Americans, thosework with the ability to pay off their mortgage but refuse to do so, In order to discover how our order to discover howparents our parents and They go against manytheir of mortgage the beliefs of andIngrandparents understand how to make got the idea that a grandparents got the idea that a mortgage traditional work for them.thinking. They put very little mortgage was a necessary evil at best, a necessary evil at best, we must go back money down, they keep their mortgage we was must go back in time to the Great in time toInthe Depression. They go against many the beliefs of choose Depression. theGreat 1920’s a commonIn the 1920’s balance as high as ofpossible, they traditional thinking. They put very little a common clause in loan gave banks adjustable rate interest-only mortgages, clause in loan agreements gaveagreements money down, they keep their mortgage right tothe demand repaymentfull of repayment right full to demand and most importantly they integrate their thebanks balance as high as possible, they choose theof loan atloan any time. Since thisSince was like the at any time. was like mortgagerate intointerest-only their overallmortgages, financial plan to asking for the moon and the stars, nothis adjustable one asking for the moon and the stars, no one continually increasethey theirintegrate wealth. This and most importantly their is how worried about it. When the stock market worried about it. When the stock market mortgage intoricher. their overall financial plan the rich get crashed on October 29, 1929 millions of crashedlostonhuge October 29,money, 1929much millions of to continually increase their wealth. This is investors sums of Thethe game is the same, but while most of itinvestors how richboard get richer. lost huge of money, on margin. Back then,sums you could buy much Americans are playing checkers, the affluent $10ofof itstock for a $1. Since value on margin. Back the then, youofcould buy The board is theThe same, but while stocks dropped, wanted aregame playing chess. good news is the the$10 of stock for afew $1.investors Since the value of the most Americans are playing checkers, the to sell, so they had to go to the bank strategies used by the wealthy work for the stocks dropped, few investors wanted to sell, affluent are playing chess. The good news out cash to cover their margin rest of America as well. Any home-owner can andsotake they had to go to the bank and take out is the strategies used by the wealthy work call. It didn’t take long for the banks to implement strategies ofAny thehomewealthy to runcash tocash coverand their margin It didn’t take for the rest of the America as well. out of start callingcall. loans increase their net worth. owner can implement the strategies of the theAmericans banks to who run were out of cash and duelong fromfor good wealthy to increase their net worth. faithfully makingloans their mortgage start calling due from payments good Americans RicEdelman, Edelman,one oneofofthe thetop topfinancial financial planners every month. However, there wasn’t any Ric who were faithfully making their mortgage in the country and aand Newa New York York Times Best demand to buy these homes, so prices planners in the country payments every month. However, there Times Best Sellingsummarizes author, summarizes in The continued to drop. To cover the margin Selling author, in this book wasn’t any demand to buy these homes, so this book The Truth About Truth About Money, “TooMoney, often,“Too people buy calls, brokers were forced to sell stocks prices continued to drop. To cover the margin often, people buy homes in a vacuum, homes in a vacuum, without considering how and once again there wasn’t a market calls, brokers were forced to sell stocks and without considering how that purchase is that purchase is going to affect other aspects for stocks so the prices kept dropping. going to affect other aspects of their lives. once again thereDepression wasn’t a market for stocks Ultimately, the Great saw the of their lives. This can beand a big mistake, and stock market fall more than 75% from its This can be a big mistake, therefore so the prices kept dropping. Ultimately, the therefore you mustthat recognize owning a 1929 highs. you must recognize owning athat home Great Depression saw the stock market fall holds important implications for the homevery holds very important implications for more than 75% from its 1929 highs. rest your plan. Although a theofrest of financial your financial plan. Although a fine goal, owning a home is not the
fine goal, owning a home is not the ultimate
More than half the nation’s banks failed and millions of homeowners, unable to raise the
Money, Ric tells the story of two brothers,
More than half the nation’s banks failed
cashand they needed to payoff their loans,tolost millions of homeowners, unable theirraise homes. Out ofthey thisneeded the American Mantra the cash to payoff loans, lost own their homes. Out of this wastheir born: Always your home outright. the American Mantra was born: Always Never carry a mortgage.
own your home outright. Never carry a Themortgage. reasoning behind America’s new mantra reasoning behind ifAmerica’s new fell wasThe really quite simple: the economy mantra was really quite simple: if the to pieces, at least you still had your home economy fell to pieces, at least you still andhad the your bankhome couldn’t take it away from you. and the bank couldn’t take Maybe youfrom couldn’t put foodyouoncouldn’t the table it away you. Maybe putor payfood youronbills, but your home was secure. the table or pay your bills, but your secure. Since Great Since thehome Greatwas Depression lawsthe have been Depression have been introduced introduced thatlaws make it illegal for banks to illegal for banks to call your call that yourmake loanitdue. The bank can no longer loan due. The bank can no longer call you call up youand upsay, and“We’re say, “We’re running a little running a little short on shortcash on and cashneed and you need you to pay your to pay off youroff loan in loanthe in next the next thirtythirty days.”days.” Additionally, the Fed is now quick to Additionally, the into Fed the is now quick to infuse infuse money system if there is money thebanks, systemasifwethere run on a runinto on the saw is in a1987 Y2K. the in FDIC wasand created the and banks, asAlso, we saw 1987 Y2K. to Also, insure banks. Still, it’s no wonder the fear the FDIC was created to insure banks. Still, of losing their home became instilled in it’s no wonder the fear of losing their home the hearts and minds of the American became instilled in the hearts and minds people, and they quickly grew to fear of the and and they60’s quickly theirAmerican mortgage.people, In the 1950’s grewfamilies to fearwould theirthrow mortgage. In the 1950’s mortgage burning to celebrate paying off their andparties 60’s families would throw mortgage home.parties And so,tobecause this fearoff of their burning celebrateofpaying their mortgage, for nearly 75 years most home. And so, because of this fear of their people have overlooked the opportunities mortgage, for nearly 75 years most people their mortgage provides to build financial havesecurity overlooked the opportunities their
mortgage provides to build financial security.
Why people hate their mortgage andtheir whymortgage you Why people hate andshouldn’t why you shouldn’t Many people hate their mortgage because
Many hate the their because theypeople know over lifemortgage of a 30 year loan, theythey know lifeinofinterest a 30 than year the loan, will over spendthe more house cost them in the first place. To save they will spend more in interest than the money becomes veryfirst tempting house costit them in the place.toTomake save a bigger down payment, or make extra money it becomes very tempting to make principal payments. Unfortunately, saving a bigger down payment, or make extra money is not the same as making money. principal Or, put payments. another way,Unfortunately, paying off debtsaving is money is not the same as makingassets. money.ByOr, not the same as accumulating mortgage put tackling anotherthe way, paying pay-off off debtfirst, is and not the the same as accumulating assets. By tackling the mortgage pay-off first, and the savings goal second, many fail to consider the important role a mortgage plays in our savings effort.
Common Home Equity Misconceptions Many Americans believe the following statements to be true, but in reality they are myths, or misconceptions:
Your home equity is a prudent investment.
FALSE Extra principal payments on your mortgage saves you money.
FALSE Mortgage interest should be eliminated as soon as possible.
FALSE Substantial equity in your home enhances your net worth.
FALSE Home Equity has a rate of return.
FALSE savings goal many failistoaconsider Every dollar wesecond, give the bank dollar we the important role a mortgage plays in our did not invest. While paying off the mortgage savings effort. Every dollar we give the saves us interest, it denies us the opportunity bank is a dollar we did not invest. While to earn interest with that money. paying off the mortgage saves us interest, it denies us the opportunity to earn interest with that money.
A tale of two brothers
Ric Edelman has educated his clients for A tale of two brothers years on the benefits of integrating their mortgage intohas their overallhisfinancial Ric Edelman educated clients plan. Inforhisyears book, New Rules of Money, Ric on The the benefits of integrating their overall financial tells themortgage story of into two their brothers, each of whom plan. In ahismortgage book, The New Rules secures to buy a of$200,000 home. Each brother earns $70,000 a year and has $40,000 in savings. The first brother, Brother A, believes in the old way of paying
off a mortgage, which aismortgage as soon astopossible. each of whom secures Brother A bites thehome. bulletEach and brother secures a fifteenbuy a $200,000 earnsmortgage $70,000 aatyear and APR has $40,000 year 6.38% and shells out in savings. The first brother, Brother A, down all $40,000 of his savings as a 20% believes in the old way of paying off payment, leaving him zero dollars ato invest. mortgage, which is as soon as possible. This leaves him with a monthly payment of Brother A bites the bullet and secures a $1,383. Since he hasat 6.38% a combined fifteen-year mortgage APR andfederal and income taxofrate 32%, as he is left shellsstate out all $40,000 his of savings a 20%an down payment, leaving zero cost with average monthly nethim after-tax dollars to invest. with a of $1,227. Also, This in anleaves efforthim to eliminate his monthly payment of $1,383. Since he has mortgage sooner, Brother A sends an extra a combined federal and state income tax $100 to his lender every month. Brother rate of 32%, he is left with an average B, in contrast, subscribes the new way of monthly net after-tax cost ofto$1,227. Also, mortgage planning, choosing instead to in an effort to eliminate his mortgage carry a big, long-term He secures sooner, Brother A sendsmortgage. an extra $100 to lender every month. loan at 7.42% APR. ahis30-year, interest-only He outlays a small 5% down payment of Brother B, in contrast, subscribes $10,000 and invests the remaining $30,000 to the new way of mortgage planning, in a safe, moneymaking account. His choosing instead to carry a side big, long-term monthly is $1,175, 100% of which mortgage.payment He secures a 30-year, interestis taxloan deductible 15 ayears, and only at 7.42% over APR.the He first outlays small over 5% down payment $10,000 and him 64% the life of theof loan, leaving invests the remaining $30,000 in a safe, a monthly net after-tax cost of $799. Every moneymaking side account. His monthly month he adds $100 to his investments (the payment is $1,175, 100% of which is tax same $100 Brother A sent to his lender), plus deductible over the first 15 years, and 64% the he’sofsaved from his lower over$428 the life the loan, leaving him mortgage a payment. His investment account earns an monthly net after-tax cost of $799. Every month $100 to his investments 8% rateheofadds return. (the same $100 Brother A sent to his
Which brother madehe’s thesaved rightfrom decision? lender), plus the $428 his loweranswer mortgage Hisby investment The canpayment. be found looking into account earns anjust 8% rate return. the future. After five of years Brother A has received $14,216 in tax savings, however he Which brother made the right decision? made zero dollars in savings and investments. The answer can be found by looking into Brother B,After on the hand, has received the future. justother five years $22,557 savings$14,216 and hisin savings and Brother A in hastax received tax savings, however he made zero dollars in investment account has grown to $83,513. savingswhat and investments. Brother B, on thelose Now, if both brothers suddenly other hand, has received $22,557 in tax their jobs? The story here turns rather bleak savings and his savings and investment Brother A. Without any money in savings, for account has grown to $83,513. Now, what he hasbrothers no way tosuddenly get through the crisis. if both lose their jobs? Even though he has $74,320 of equity The story here turns rather bleak for in his Brotherhe A. can’t Without money in savings, home, getany a loan because he doesn’t he has no way to get through the crisis. have a job. With no job and no savings, he Even though can’t make his monthly payments and has no choice but to sell his home in order to avoid foreclosure. Unfortunately, at this point it’s a fire sale so he must sell at a discount, and
3
A Tale of Two Brothers Adapted from the book, The New Rules of Money
Our story begins with two brothers, each earning $70,000 a year. They each have $40,000 in savings and both are buying $200,0000 homes.
Brother “A” believes in “The Old Way” – paying off the mortgage as soon as possible
Brother “B” believes in “The New Way” –carrying a big, long mortgage
then pay real estate commissions. Brother B, while not particularly happy at the prospects of searching for a new job, is not worried becauseofheequity has $83,513 in savings to he has $74,320 in his home, tide him get over.a loan He doesn’t need a loan and can he can’t because he doesn’t easily make his monthly payments, even if he have a job. With no job and no savings, can’t make his payments and isheunemployed formonthly years. He has no reason to has no choice but to sell his home in panic, as he is still in control. Remember… order to avoid foreclosure. Unfortunately,
at this is point it’s a fire sale so he must sell Cash King! at a discount, and then pay real estate
15-year mortgage at 6.38% APR
30-year mortgage at 7.42% APR
$40,000 Big Down Payment
$10,000 Big Down Payment
$0 left to invest
$30,000 left to invest
$1,383 Monthly Payment
$1,175 Monthly Payment
(56% is tax deductible first year/33% average)
(100% is tax deductible first 15 yeas/64% average)
$1,227 Monthly Net After-Tax Cost
$799 Monthly Net After-Tax Cost
Sends $100 monthly to lender in effort to eliminate mortgage sooner
Adds $100 monthly to investments, plus $428 saved from lower mortgage payment where account earns 8% rate of return
Results after 5 Years Received $14,216 in tax savings
Received $22,557 in tax savings
has $0 in savings and investments
has $83,513 in savings and investments
What if both brothers suddenly lost their jobs? Has no savings to get him through crisis
Has $83,513, in savings to tide him over
Can’t get a loan – even though he has $74,320 more in equity than his brother – because he has no job
Doesn’t need a loan
Must sell his home or face foreclosure because he can’t make payments
Can easily make his mortgage payments even if he’s unemployed for years
At this point – it’s a fire sale – he must sell at a discount and pay real estate commissions (6-7 %)
has no reason to panic since he’s still in control – remember... cash is KING!
commissions. Now, let’s say neither brother lost his job. We’ll check in on them after fifteen years have Brother B, whilethey not particularly passed since purchasedhappy their athomes the prospects of searching for a new job, and evaluate the results of their financing is not worried because he has $83,513 in strategies. Brother A He hasdoesn’t now need received savings to tide him over. $25,080 taxeasily savings, $30,421 in a loan andincan makehehishas monthly payments, even if he savings and investments (once his home is unemployed years.saving He hasthe noequivalent was paid off hefor started reason to panic, as he is still in control. of his mortgage payment each month), and Remember… owns his home outright. Not too bad, right? Cash is King!
Now let’s check on his Brother. Brother B Now, let’s say neither brother lost his job. has received $67,670 in tax savings and has We’ll check in on them after fifteen years $282,019 in since savings investments. have passed theyand purchased their If he chooses to, he can pay off the remaining homes and evaluate the results of their financing strategies. A has now mortgage balance ofBrother $190,000 and still have received $25,080 in tax savings, he has $92,019 left over in savings, free and clear. $30,421 in savings and investments (once
Results After 15 Years Received $25,080 in tax savings
Received $67,670 in tax savings
Has $30,421 in savings and investments
Has $282,019 in savings and investments
Owns home outright
Remaining mortgage balance is $190,000 – and he has enough savings to pay it off and still have $92,019 left over, free and clear
Results After 30 Years Received $25,080 in tax savings
Received $107,826 in tax savings
Has $613,858 in savings and investments
Has $1,115,425 in savings and investments
Owns home outright
Owns home outright – so starts fresh and enjoys the same benefits once again
his homelet’s was assume paid off he started saving Finally, that rather than pay the equivalent of his mortgage payment off his mortgage at fifteen years, Brother B each month), and owns his home outright. decides to ride out the whole thirty years of the Not too bad, right? loan’s life. While Brother A has still received only inon taxhissavings, savings Now $25,080 let’s check Brother.his Brother B and investments grown $613,858, has received have $67,670 in taxto savings and and has $282,019 in savings and investments. he still owns his home outright. Brother B, If he to, he has can received pay off thea whopping on thechooses other hand, remaining mortgage balancehas of $190,000 $107,826 in tax savings, accumulated and still have $92,019 left over in savings, an incredible $1,115,425 in savings and free and clear. investments, and also owns his home outright. Heassume can start Finally, let’s thatover ratherfresh than and pay enjoy off his mortgage fifteenagain. years,Unfortunately, Brother the same benefitsat once B decides to ride out the whole thirtythe same the majority of Americans follow yearsas of Brother the loan’s A they path A,life. as While it’s theBrother only path has still received only $25,080 in tax know. Once the path of Brother B is revealed savings, his savings and investments to them, a paradigm shifting epiphany often have grown to $613,858, and he still occurs as they Brother B’sB,path enables owns his homerealize outright. Brother on the homeowners to received pay their ahomes off sooner (if other hand, has whopping they choose to), while significantly increasing
Are you still doing this?
“Here is is an an extra extra $100 $100 “Here principal payment Mr. Banker. Banker. Don’t Don’t pay pay me me any any interest interest principal payment Mr. on it. it. IfIf II need need itit back, back, I’ll I’ll pay pay you you fees, fees, borrow borrow itit back back on on on your terms, terms, and and prove prove to to you you that that II qualify.” qualify.” your
Money you give the bank is money you’ll never see again unless you refinance or sell.
Many Americans believe the best way to
Certified Financial Planners) contained
$107,826 in in tax savings, savings, has has accumulated accumulated Certified Financial contained believe bestasway $107,826 yearMany loanAmericans and aa 30-year 30-year loan,the as well well thetotax tax 4-5%, their net worth worthtaxand and maintaining maintaining the added added year the chances chances arePlanners) pretty good good that you you loan as the their net the are pretty that thethe first academic academic study undertaken on pay offand a home home early earlyloan, is to to as pay extra extra principal 4-5%, an incredible incredible $1,115,425 in savings savings and the first study undertaken on pay off a is pay principal an $1,115,425 in and savings intomortgage. safe side side investment account can benefits of liquidity liquidity and safety the entire way. way. savings can the earnquestion 5% on onofyour your money. Interest rates into aa safe investment account benefits of entire earn 5% money. Interest rates 15-year versus 30-year on your your Similarly, many finance finance investments, and and alsosafety owns the his home home the question of 15-year versus 30-year on mortgage. Similarly, many investments, and also owns his earning a conservative rate of return, you will are relative. In the 1980’s, money was costing a conservative rate ofloan return, youyou will are relative. In the 1980’s, moneythe was30-year costingloan mortgages. They concluded the 30-year loan professors think aa 15-year 15-year loan saves you outright. He He can can start start over over fresh fresh and and enjoy enjoy earning mortgages. They concluded professors think saves outright. have enough to pay your home off in 13½ 15%, but individuals could still earn 15% on is better. Based on the same logic, wouldn’t money by reducing the interest you pay. the same benefits once again. Unfortunately, have enough to pay your home off in 13½ 15%, but individuals could still earn 15% on is better. Based on the same logic, wouldn’t money by reducing the interest you pay. the same benefits once again.home Unfortunately, Successfully managing years (or in in 15 15 yearsAndrew with $25,000 $25,000 to spare!). spare!). their money. money. Due Due to to the the tax tax deductibility deductibility of of However, Doug Andrew points out out in his his the majority majority of of Americans Americans follow follow the the same same years (or years with to their However, Doug points in the equity to increase liquidity, an interest-only interest-only loan be better better than than an book, one Missed Fortune,Fortune that this thistalks thinking is mortgage Chapter one in Missed Missed Fortune talks about path as as Brother Brother A, A, as as it’s it’s the the only only path path they they Chapter mortgage interest and and compounding returns, an loan be an book, Missed Fortune, that thinking is in about path interest compounding returns, amortizing loan? If mortgage money cost you flawed. If you do the math, you find if you know. Once the path of Brother B is revealed safety, rate of return, and the $25,000 mistake made by millions of you can borrow at a higher rate and invest atyou If mortgage money If you do the made math, you find if youof youamortizing know. Once the path of Brother B is revealed theflawed. $25,000 mistake by millions can borrowloan? at a higher rate and investcost itit at 4-5%, the chances are pretty good that you set aside the monthly payment difference to them, a paradigm shifting epiphany often Americans who choose the fifteen-year loan. aa lower 4-5%, theand chances are pretty good that you lower rate and still make make significant profit. set asidewho thechoose monthlythe payment difference them, a paradigm shifting epiphany often Americans fifteen-year loan. rate still aa significant profit. taxto deductions occurs as as they they realize realize Brother Brother B’s B’s path path occurs enables homeowners to pay pay their homes homes off homeowners to their In enables 2003, Doug Doug Andrew, aa top top financial planneroff In 2003, Andrew, financial planner sooner (if they choose to), while significantly sooner theythe choose while significantly from Utah,(if was was the first to), to clearly clearly articulate from Utah, first to articulate increasing their their net net worth worth and and maintaining maintaining increasing the strategy the wealthy have been using thethestrategy the wealthy have and beensafety using added benefits benefits of liquidity liquidity the the added of and safety forentire decades in his his book, book, Missed Missed Fortune. Fortune. The Thethe for decades in way. entire way.
book isis based based on on the the concepts concepts of of successfully successfully book managing home equity to increase liquidity, managing home equity to increase liquidity, Successfully managing home Successfully managing home safety, rate rate of of return, return, and and tax tax deductions. deductions. safety, equity toreaders increase liquidity, equity to increase Doug educates to view viewliquidity, their mortgage mortgage Doug educates readers to their safety, rate of return, and and home equity equity through different lens, the the safety, ratethrough of return, and and home aa different lens, same lens used by the affluent. He shows taxlens deductions same used by the affluent. He shows tax deductions how relatively minor changes changes in in home home equity equity how relatively minor In 2003, 2003, Doug Doug Andrew, Andrew, aa top top financial financial In perception and positioning can produce perception andUtah, positioning canto clearly produce planner from from was the the first first planner Utah, was to clearly monumental long-term effects in financial monumental effects in financial articulate the thelong-term strategy the the wealthy have articulate strategy wealthy have security. security. been using for decades in his book, Missed
been using for decades in his book, Missed Fortune. The The book book is is based based on the concepts concepts Fortune. the Many Americans believe theonbest best way to to Many Americans believe the way of successfully managing home equity to of successfully managing home equity to payincrease off aa home home earlysafety, to pay pay extra principal pay off early isis to principal liquidity, rateextra of return, return, and increase liquidity, safety, rate of and on your mortgage. Similarly, many finance ontax your mortgage. Similarly, many finance tax deductions. Doug educates readers deductions. Doug educates readers professors thinkmortgage 15-year loan saves you to view view their their mortgage andloan homesaves equityyou professors think aa 15-year to and home equity money byaareducing reducing the the interest you pay. through different lens, lens, the sameyou lens pay. used money by the interest through different same lens used However, Doug Andrew points out in his book, by the affluent. He shows how relatively However, Doug Andrew pointshow outrelatively in his book, by the affluent. He shows minorFortune, changesthat in home home equity perception perception Missed Fortune, that this thinking thinking flawed. IfIf minor changes in equity Missed this isis flawed. and positioning canfind produce monumental you do the math, you if you set aside the and positioning can produce monumental you do the math, you find if you set aside the long-term effects in financial security. long-term effects in financial security. monthly payment difference between a 15-
monthly payment difference between a 15-
between aa 15-year 15-year loan loan and and aa 30-year 30-year loan, loan, between as well well as the the tax tax savings savings intoteaches safe side side Cram Investment Groupinto teaches an as as aa safe Cram Investment Group an investment account earning a conservative educational seminar for the public based investmentseminar account for earning conservative educational the apublic based rate of of return, you will willFortune have enough enough to pay pay rate you have to largely onreturn, the Missed Missed concepts. In largely on the Fortune concepts. In your home off in 13½ years (or in 15 years your home off in 13½ years (or in 15 years the seminar, we break down the four key thewith seminar, wetobreak down the one four inkey $25,000 to spare!). Chapter Chapter one with $25,000 spare!). ininto benefits of integrating your mortgage benefits integrating your mortgage into MissedofFortune Fortune talks about about the $25,000 $25,000 Missed talks the your financial plan (increased liquidity, safety, your financial plan (increased liquidity, safety, mistake made made by by millions millions of of Americans Americans who who ratemistake of return, return, and tax deductions) deductions) in order order to to rate of and tax in choose the fifteen-year loan. choose the fifteen-year loan.
can earn earn 5% 5% on on your your money. money. Interest Interest rates rates can are relative. relative. In In the the 1980’s, 1980’s, money money was was costing costing are 15%, but but individuals individuals could could still still earn earn 15% 15% on on 15%, their money. Due to the tax deductibility of their money. Due to the tax deductibility of mortgage interest and compounding returns, mortgage interest and compounding returns, you can cash borrow at aa higher higher rate and invest invest By having available ftorrate emergencies can borrow at and By you having cash available ftor emergencies at aa lower lower rate rate and still still make make significant at and aa significant andititinvestment investment opportunities, most homeand opportunities, most homeprofit. profit.
Large equity in your home can be a big disadvantage
owners are are better better off off than than ifif their their equity equity isis tied tied owners up in in their their residence. residence. Large, Large, idle idle equity, equity, also also up look at at each each one one in in more more detail detail look Large equity in your home Large equity in your home called ‘having all your eggs in one basket,’ called ‘having all your eggs in one basket,’ Cram Investment Investment Group Group teaches teaches an an OurCram goal is to help clients conserve their home can be aaifif big big disadvantage can can be risky risky the homeowner homeowner suddenly Our goal is to help clients conserve their home be disadvantage can be the suddenly educational seminar seminar for for the the public public based based educational equity, not consume it. We are one of the needs cash. While employed and in excellent equity, noton it. Fortune We are concepts. one of theIn largely onconsume the Missed Missed Fortune concepts. In needs While andemergencies in excellent largely the By cash. having cashemployed available ftor ftor By having cash available emergencies few financial planning firms who encourage health, borrowing onopportunities, home isis easy, easy, buthomemost the seminar, we break break down theencourage four key key fewthe financial planning firms who health, aa home but most seminar, we down the four andborrowing investmentonopportunities, most and investment most homeclients to secure debt in order to become debt benefits of integrating your mortgage into people, especially retirees, unexpectedly clients to secure debt in order become debt benefits of integrating yourtomortgage into people, especially owners are better betterretirees, off than than ifif unexpectedly their equity equity owners are off their your financial plan plan (increased (increased liquidity, liquidity, safety, safety, need freeyour sooner. need cash when they are sick, unemployed or financial free sooner. is cash tied up up in their their residence. Large, idle idle or when theyresidence. are sick, unemployed is tied in Large, rate of of return, return, and and tax tax deductions) deductions) in in order order to to haveequity, rate insufficient income. Obtaining a home also called called ‘having all your youraeggs eggs in insufficient income. Obtaining home also ‘having all in In look Aprilat 1998, Thein Journal of Financial Financial haveequity, look at 1998, each one one in more more detail In April The Journal of each detail one basket,’ can be risky if the homeowner loan under these circumstances can be either basket,’ be risky if the under thesecan circumstances canhomeowner be either Planning (published (published by by the the Institute Institute of of loanone Planning suddenly needs cash. While While employed employed impossible orneeds very expensive. expensive. suddenly cash. impossible or very Our goal goalFinancial is to to help help clients clients conserve their Certified Financial Planners) contained Our is conserve their Certified Planners) contained and in in excellent excellent health, health, borrowing borrowing on on aa and home equity, not consume it. We are one the first academic study undertaken on home equity, not consume it. We are one How many of us feel when we go to the bank home easy, butwhen most we people, especially the first academic study undertaken on Howhome manyisisofeasy, us feel go toespecially the bank but most people, of question the few few financial financial planning firms who who of the planning firms the of 15-year versus 30-year retirees,need unexpectedly need cash when they we almost almost need to prove prove we we don’t need thethey the question of 15-year versus 30-year we retirees, unexpectedly need cash when to don’t need the encourage clients to secure secure debt in order order to encourage clients to debt in to are sick, unemployed or have insufficient mortgages. They concluded the 30-year loan money before they’ll loan it to us? The bank are sick, unemployed mortgages. They free concluded the 30-year loan money before they’ll loanorit have to us?insufficient The bank become debt debt free sooner. become sooner. income. Obtaining a home home loan under under these better. Based on the the same logic, logic, wouldn’t wouldn’t wants income. Obtaining a loan these wants to know we have the ability to repay repay isis better. Based on same to know we have the ability to circumstances can be either impossible or an Ininterest-only interest-only loan be better better than an an the can be how either impossible the circumstances loan. You You can can imagine imagine how aa conversation conversationor an loan be than loan. April 1998, 1998, The The Journal of Financial Financial In April Journal of very expensive. very amortizing loan? mortgage money cost you might might goexpensive. with your your banker: banker: “I“I brought brought up up amortizing IfIf mortgage Planningloan? (published by the themoney Institutecost of you go with Planning (published by Institute of
your loan application up to the board this There are actually three primary reasons:
How many of us feel when we go to the morning and I explained to them you’re going bank we almost need to prove we don’t through some hard financial times, you’re need the money before they’ll loan it to us? unemployed, your credit is not so good and The bank wants to know we have the ability maybe lendcan youimagine some cash to repaythey the could loan. You how to a get through these rough times. Their response conversation might go with your banker: “I was... ‘Fatupchance!’ brought your loan application up to the board this morning and I explained to them What many is that even you’re goingpeople throughdon’t somerealize hard financial if they’ve consistently been making double times, you’re unemployed, your credit is not so good and maybe they could mortgage payments for five yearslend in ayou row, the some cashhas to get rough times. bank still no through leniency.these If suddenly they Their response was... ‘Fat chance!’ experience a financial setback, the bank will
not care. They can go to the bank and plead,
What many people don’t realize is that even “I never thought in a million years this would if they’ve consistently been making double happen to me, but it did. I’ve been paying my mortgage payments for five years in a row, mortgage in has advance for years, how about if the bank still no leniency. If suddenly I justexperience coast on my mortgage payments for a they a financial setback, the bank fewnot months?” Theycan get go thetosame answer every will care. They the bank and plead, never thought in ajust million time... “I‘Fat chance!’ Banks don’tyears workthis that would happen toofme, it did. I’ve been way. Regardless howbut much you’ve paid your paying my down mortgage in advance for payments years, mortgage or how many extra how about if I just coast on my mortgage you’ve made, next month’s payment is still payments for a few months?” They get the due in its entirety no matter what. same answer every time... ‘Fat chance!’ Banks just don’t work that way. Regardless of how much you’ve paid your mortgage down or how many extra payments you’ve made, next month’s payment is still due in its entirety no matter what.
mortgage payment, or have an additional financial times, would your rather have $25,000 of equity trapped in your home? $25,000 of cash to help you make your Almost every person who has ever lost their mortgage payment, or have an additional home to foreclosure would have been better $25,000 of equity trapped in your home? off if they hadperson their who equity from Almost every hasseparated ever lost their 1. Liquidity their home in a liquid, safe, conservative side These three elements are also commonly home to foreclosure would have been better 2. Safety be equity used toseparated make mortgage off if that they could had their from used asofthe test of a prudent investment. fund 3. Rate return their home in a liquid, safe, conservative side payments during their time of need. When evaluating a potential investment, fund that could be used to make mortgage These three elements experienced investors are will also ask commonly the following The importance of liquidity became all too payments during their time of need. used questions: as the test of a prudent investment. three clear when the stock market crashed in cash position. Why in the world would you want to have the1.equity removed from your Liquidity home? There are 2. actually Safetythree primary reasons: 3. Rate of return
When evaluating a potential investment, experienced1.investors will ask the following How liquid is it? three questions: (Can I get my money back when I want it?)
2. How 1. How liquid issafe it? is it?
(Can I get my back when I want it?) (Is itmoney guaranteed or insured?)
3. Whatsafe rate ofisreturn 2. How it? can I expect? (Is it guaranteed or insured?)
Home equity fails all three tests of a prudent investment. Let’s examine each can of these core 3. What rate of return elements in more detail to better understand I expect? why home equity fails the tests of a prudent Home equity and, fails allmore three tests of a prudent investment, importantly, why investment. Let’s examine each of these core home-owners benefit by separating the elements morehome. detail to better understand equity fromin their why home equity fails the tests of a prudent investment, and, more importantly, why home-owners benefit by separating the equity from their home.
The importance became too October of 1987.of Ifliquidity someone had alladvised clear when the stock market crashed in you to sell your stocks and convert to cash, October of 1987. If someone had advised they would have been a hero. Or, if you had you to sell your stocks and convert to cash, enough liquidity you could have weathered they would have been a hero. Or, if you had the storm. Those with other liquid assets were enough liquidity you could have weathered able to remain invested. Theyliquid wereassets rewarded the storm. Those with other aswere theable market rebounded to remain invested.and Theyrecovered were fully withinas90the days. However, those and without rewarded market rebounded recovered fully within 90 days. However, liquidity were forced to sell while the market those without liquidity were forcedsignificant to sell was down, causing them to accept while the market was down, causing them losses. In Missed Fortune, Doug Andrew tells to accept significant losses. In Missed the story of a young couple who learned what Fortune, Doug Andrew tells the story of a he calls “The $150,000 Lesson on Liquidity”. young couple who learned what he calls In“The 1978 this couple built a beautifulIn home $150,000 Lesson on Liquidity”. that be featured Better home Homesthat and 1978would this couple built a in beautiful Gardens. couple’s home appreciated would be The featured in Better Homes and The by couple’s inGardens. value, and, 1982,home it wasappreciated appraised for in value, by 1982,They it was appraised for just underand, $300,000. had accumulated just under $300,000. They had accumulated a significant amount of equity, not because a significant amount of equity, not because they had been making extra payments on they had been making extra payments on the property, but because market conditions the property, but because market conditions improved improvedover overthat thatfour-year four-yearperiod. period.
Why separate equity from your home?
Separating equity to increase liquidity
In the book, Missed Fortune, Doug Andrew suggests people strongly Why separate equity from consider separating as much equity your as theyhome? possibly can from their house, and place it over in a cash position. in the In the book, Missed Fortune, DougWhy Andrew world would youstrongly want to have the equity suggests people consider separating as much equity as they possibly removed from your home?
What is the biggest secret Separating equity toin real estate? Your mortgageliquidity is a loan against your income, increase not a loan against the value of your house. What is the biggest secret in real estate? Your Without an income, in many cases you cannot mortgage is a loan against your income, not a get a loan. If you suddenly experienced loan against the value of your house. Without This couple thought they had the world by difficult financial your get rather an income, in manytimes, caseswould you cannot a This couple thought they had the world the tail. They had a home valued at $300,000 have $25,000 of cash to help you make your loan. If you suddenly experienced difficult by the tail. They had a home valued at
can from their house, and place it over in a
“It’sbetter bettertotohave haveaccess access “It’s tothe theequity equityororvalue valueofofyour yourhome home to andnot notneed needit,it,than thantotoneed needit itand and and notbe beable abletotoget getatatit.”it.” not
during which forced with first and second mortgages owingowing only during highs. And, most importantly, he learned better tomost have access to theheequity or value o $300,000 with first and second mortgages owing who which got stucktime withthe the lender deficiency balance ofhighs. waswas forced toof to with first and second mortgages owing only importantly, learned betterAnd, to have access to the equity or value of $300,000 with first and second mortgages who got stucktime withthe the lender deficiency balance your and not need it, than toofneed it an only $150,000.They Theyhad had“made” “made”$150,000 $150,000ininfour four pay $30,000 ontheir their credit report? The original thefirst first mortgage and also accrued four never tohome allow anot significant amount equity your and need amount it, than toofneed it and only$150,000. $150,000.They Theyhad had“made” “made”$150,000 $150,000inin $30,000 on mortgage creditand report? The original pay the also accrued an an never $150,000. four tohome allow a significant equity not be able to get at it. Keeping home equity short years. owners, of course! additional $30,000 of interest and penalties. short years. to accumulate in his property. not be able in to his getproperty. at it. Keeping home equity short years. owners, of$30,000 course! of interest and penalties. to accumulate additional short years. safe is really a matter of positioning yourself By the time the home finally sold, less the safe is really a matter of positioning yourself to t By This the time thenothome finally sold, less the act instead of react to market conditions They had the misconception that the couple only had a foreclosure They had the misconception that the equity in Home equity is not the same as cash in the act instead reactthe to same marketasconditions overover They hadhad thethe misconception that thethe equity in This coupleinnotaccrued only hadindebtedness, a foreclosure guess Home They misconception that equity isof not cash in the $30,000 $30,000 in accrued indebtedness, guess which you have no control. equity in their home had a rate of return when, in appear on their credit report for seven years, their home hadaarate rateof return when,when, fact,initit who bank; only cash incontrol. the is the same which you have equity their home had aofrate of return appear onstuck theirwith creditthe report for seven years,of bank; theirinhome had return when, ininfact, only cash innothe bankbank is the same as as got deficiency balance who got stuck with the deficiency balance of fact, it was just a number on a sheet of paper. the report also showed a deficiency balance justjust number onaon asheet sheet paper. cash in the bank. Being house fact,was it was a number a sheet of paper. the reporton alsotheir showed a deficiency balance was just aa number on ofofpaper. in the bank. Being house richrich andand cashcash $30,000 credit report? The original cash $30,000 on theironcredit report? The original owing$30,000 $30,000 on a home they had owing a home they had lostlost Separating equity to poor is a dangerous position to be Separating equity poor is a dangerous positiontoto be in. Itin.isIt is owners, ofcourse! course! nearlyone year Then, series of unexpected unexpected events reduced Then, series of unexpected unexpected events reduced owners, ofone nearly year Then, aa series of events reduced Then, aa series of events reduced better to have access toofthe equity or value increase safety of principal better to have access to the equity or value of of safety principal earlier.InIna atime time financial setback they their income to almost almost nothingfor fornine ninemonths. months. their income to almost almost nothing for nine nine This earlier. ofof financial setback they lostlost increase their income to nothing their income to nothing for couple not only had a foreclosure appear your home and not need it, than to need it and couple not onlyvaluable had a foreclosure appear your home and notTimes, need it,inthan to need it and one their most valuable assets due They couldn’t borrow money tokeep keep theirto keep This The Seattle an article published one ofoftheir most assets due to to a a They couldn’t borrow money to their months. They couldn’t borrow money The Seattle Times, in an article published months. They couldn’t borrow money to keep onlack their creditreport report forseven seven years, not beMarch able to get atKeeping it. Keeping home equity their credit forhad years, thethe notin beMarch to get at it.reported, home equity liquidity. If they separated their mortgage payments current currentbecause becausewithout inable 2004, “Remember lack ofofliquidity. If they had separated their mortgage payments 2004, reported, “Remember that that their mortgage payments currentwithout because onreport their mortgage payments current because also showed a deficiency balance owing safe is really a matter of positioning yourself $150,000 home equity and repositioned an they did did not nothave havethe theability abilitytoto report also showed aequity deficiency balance owing safehousing ishousing reallyprices a prices matter of positioning and do level off. $150,000 ininhome and repositioned an income income they cancan and do level off.yourself without ansix income theythey didnot nothave have the ability $30,000 without an income they did the ability on a home they had lost nearly one to act instead of react to market conditions it into a safe side account, they would have repay. Within months had sold two sometimes decline – witness Southern $30,000 on a side homeaccount, they had lostwould nearlyhave one to They actThey instead of react to market conditions it into a safe they repay. Within six months they had sold two sometimes decline – witness Southern to repay. Within sixmonths months theyhad hadsold sold two year to repay. Within six they two easily been their mortgage other properties to bring bring theirmortgage mortgage outof of earlier. Inaable a time of financial setback they over over which you have no control. California just a little more than a decade easily been toto make their mortgage other properties to their out year earlier. Inable time ofmake financial setback they which you have no control. California just a little more than a decade other properties to bring bring their mortgage out lost other properties to their mortgage payments and prevented this series ofdue to ago, delinquency. They soon soon realized that orderout ago, when prices 20 percent to 30 oneofoftheir their mostvaluable valuable assets payments and prevented this series ofdue delinquency. They realized that ininorder toto lost when prices tooktook a 20a percent to 30 one most assets to of delinquency. They soon they realized that events. protect their $150,000 $150,000 ofequity equity they would have of delinquency. They soon realized that inin a aevents. percent corrective jolt downward.” Real estate protect their of would have lackofofliquidity. liquidity.If Ifthey theyhad had separated their percent corrective jolt downward.” Real estate lack separated their At this point in the story, Doug admits the to sell their home. As Murphy’s Law would have order to protect their $150,000 of equity they equity is no safer other investment At this pointininhome the story, Doug admits the to sell their home. As Murphy’s Lawofwould order to protect their $150,000 equityhave they $150,000 equity is no safer thanthan anyany other investment $150,000 equity and repositioned in home equity and repositioned youngcouple couple was really and wife, it, would have have to to sell sell their their home. home.AsAsMurphy’s Murphy’s ityoung was really hehe and hishis wife, it, the the whose value is determined byexternal an external whose value is determined by an intoa asafe safe sideaccount, account,they they would have it Sharee. into side would have Sharee. Despite objections from editor, previously strong real estate marketturned turned soft. Despite objections from hishis editor, previously strong real market soft. market over which personally Law would would have it,estate thepreviously previously strong real easily market over which we we personally havehave no no have it, the strong real been able to make their mortgage easily been able to make their mortgage Doug insisted the story remain in the book The Seattle Times, in an article published Doug insisted the story remain in the book control. In fact, due to the hidden “risks of life The Seattle Times, in an article published control. In fact, due to the hidden “risks of life,” estate market market turned turnedsoft. soft. payments and prevented this series of events. and prevented this series events. because hewanted wanted readers to know Although they they reduced reducedtheir theirasking askingprice priceseveral several payments because he hishis readers to of know hehe in real real estate equity is not nearly as safe as in March 2004, “Remember thatman estate equity isreported, not nearly as safe as March 2004, reported, “Remember thatmany understands first hand the importance of times from $295,000 down to $195,000 – they understands first hand the importance of – from $295,000 down to $195,000 – they other conservative assets. Although they they reduced reduced their their asking asking price price At this point in the story, Doug admits the housing other conservative assets. housing prices and do level off.and prices cancan andinvestments doinvestments level off.and this pointassets inassets theinstory, Doug admits the positioning in financial instruments could not find find a buyer. buyer. Sadly,$295,000 theygave gaveup upthe the to Atpositioning financial instruments a Sadly, they A home that is either mortgaged to the hilt A home that is either mortgaged to the hilt several times – from down times – from $295,000 down to young young coupleliquidity wasreally really heand and hisan wife, They couple was he his wife, thatmaintain maintain liquidity in the event of home in foreclosure foreclosure to tothe themortgage mortgagelender. lender. that in the event of an sometimes decline – witness Southern or owned totally free and clear provides the They sometimes decline – witness Southern or owned totally free and clear provides the $195,000 –– they theycould couldnot notfind findaabuyer. buyer.Sadly, Sadly, Sharee. Despite objections from his editor, Despite objections from had his editor, emergency. If Doug and Sharee had access California Sometimes sad sad stories storiesonly onlyget getsadder. sadder.The Thetwo two Sharee. emergency. If Doug and Sharee access greatest safety for the homeowner. greatest safety themore homeowner. California just afor little a decade just a little more thanthan a decade ago,ago, they gaveonup up the homein inforeclosure foreclosure the Doug the home totothe insisted the story remain in the book their home’s equity, they could have used when prices took a 20 percent to 30 percent mortgages on the property propertywere wereininthe theamounts amounts Doug insisted the story remain inhave the book tototheir home’s equity, they could used the when prices took a 20 percent to 30 percent mortgageand lender. Sometimes sad stories because lender. Sometimes sad stories weather the hishisreaders of $125,000 $25,000, respectively. The it ittotoweather the $125,000 and $25,000, respectively. The because wanted readersto toknow know hehewanted he he corrective corrective downward.” estate equity joltjolt downward.” RealReal estate equity only mortgage sadder. The two mortgages on the get sadder. The two mortgages on the financial storm until they could get back second mortgage holder outbid the first one financial storm until they the could get back of of holder outbid the first one understands first hand theimportance importance understands first hand is no safer than any other investment whose is no safer than any other investment whose property were in the the amounts of $125,000 were in amounts $125,000 theirfeet. feet. Doug from his own at the ensuing auction, feeling that,of much like onontheir Doug from his own ensuing auction, feeling that, much like positioning assets inlearned financial instruments positioning assets inlearned financial instruments value is determined external market is determined by by an an external market experiencethe the importance maintaining value theand owners, ititrespectively. wasininaagood good position. experience importance of of maintaining original owners, was position. $25,000, respectively. The second that $25,000, The second thatmaintain maintainliquidity liquidityin inthetheevent eventof ofan an over which we we personally havehave no control. over which personally no control. flexibility toto ride outout market lows that house had appraised flexibilityininorder order ride market lows Knowing that the the house hadbeen been appraised for mortgage holder outbid the one the holder outbid thefirst first oneatatfor the emergency. If IfDoug Sharee hadhad access emergency. Dougand and Sharee access In In fact, due to the hidden “risks of life,” real real fact, due to the hidden “risks of life,” and take advantage of market highs. And, and the obligation owing was only and take advantage of market highs. And, $300,000, and the obligation owing was only ensuing auction, auction, feeling feeling that, that,much muchlike likethe the tototheir home’s equity, they could have used their home’s equity, they could have used most importantly, he learned never to allow a $150,000, it owners, thought it could turn around and most importantly, he learned never to allow aestate thought it ititcould turn around and equity is not nearly as safe as many estate equity is not nearly as safe as many was aa good original owners, was inin goodposition. position. tosignificant thethefinancial storm until they toweather weather financial until they significant amount of equity tostorm accumulate in inother amount of equity to accumulate sell the property property to to cover coverthe theinvestment. investment.ItIttook took itit conservative investments and assets. other conservative investments and assets. house Knowing that that the thesell, househad hadbeen beenappraised appraised could get could getback backonontheir theirfeet. feet.Doug Douglearned learned A home his hisproperty. property. nine long months months to to sell,during duringwhich whichtime timethe the thatthat is either mortgaged to the hilt hilt A home is either mortgaged to the and the obligation owing for $300,000, $300,000, and the obligation owing Home equity is experience not thethe same as cash in the hishis own the importance Home equity is not same as cash in of theof or owned totally free and clear provides the lender was forced forced to to pay paythe thefirst firstmortgage mortgageand and from from ownexperience the importance or owned totally free and clear provides the only $150,000, itit thought turn $150,000, thought itofcould could turn maintaining bank; in in the bank is the same as accrued an $30,000 interest bank;only onlycash cash the is to the same alsowas accrued an additional additional $30,000itof interest flexibility inbank outas maintaining flexibility inorder order toride ride out greatest safety for for thethe homeowner. greatest safety homeowner. and toto cover the andBy sell the property cover the market cash Being house rich cash andaround penalties. the time the finally sold, cashinlows inthe thebank. bank. Being house rich and cash penalties. Bysell thethe timeproperty thehome home finally sold, and advantage ofand market lows andtake take advantage ofmarket market investment. ItIt in took nine months sell, position to to bebe in. in. It isIt is lessinvestment. the $30,000 accrued indebtedness, guess took ninelong long monthstoto sell, poor poorisisa adangerous dangerous position $30,000 in accrued indebtedness, guess
Separating equity to increase Separating equity to increase safety principal safety of of principal
“Home equity is not “Home equity is not the same asas cash in in thethe the same cash bank. Only cash in in thethe bank. Only cash bank is is the same asas bank the same cash in in thethe bank.” cash bank.”
“Home equity is not the same as cash in the bank. Only cash in the bank is the same as cash in the bank.”
the Enron Corporation collapsed a few years ago, and thousands lost their jobs and homes, again in Houston, Texas. What would happen in the Seattle area if Microsoft or Boeing had major lay-offs? Money you give the bank is money you’ll never see again unless you refinance or sell. When the people in Houston pleaded, “Mr. Banker, I’ve been making extra mortgage payments for years. I’m well ahead of schedule. Will let you let me coast for a while?” The bank replied, “Fat Chance!”
Americans typically believe home equity is a very safe investment. In fact, according to a recent study, 67% of Americans have more of their net worth in home equity than in all other investments combined. However, if 100 financial planners looked at a client portfolio that was 67% weighted in a single investment, 99 out of 100 of them would immediately To reduce the risk of foreclosure recommend the client diversify to reduce during unforeseen set-backs, their risk and increase safety of principal. keep your mortgage balance as Holding large amounts of home equity puts the homeowner at unnecessary risk. This risk high as possible could be greatly reduced by diversifying their Is your home really safe? Unfortunately, home equity into other investments. many home buyers have the misconception An example of the necessity of keeping your that paying down their mortgage quickly home’s equity safely separated from your is the best method of reducing the risk property can be can be found in Houston, of foreclosure on their homes. However, Texas. When oil prices fell to all time lows in reality, the exact opposite is true. As in the early 1980’s the city of Houston was homeowners pay down their mortgage, hit hard. Thousands of workers were laid off they are unknowingly transferring the risk and ultimately forced to sell their homes. from the bank to themselves. When the With a glut of homes on the market, housing mortgage balance is high, the bank carries prices plummeted. Unfortunately, there the most risk. When the mortgage balance were far too many sellers and far too few is low, the homeowner bears the risk. With a buyers. Homeowners were unable to sell and low mortgage balance the bank is in a great unable to make their mortgage payments. position, as they stand to make a nice profit As a result, 16,000 homes were foreclosed. if the homeowner defaults. In addition to Did these 16,000 families suddenly become assuming unnecessary risk, many people who bad people? No, they just couldn’t make their scrape up every bit of extra money they can to mortgage payments. Just prior to this series apply against principal often find themselves of events many of these people were making with no liquidity. When tough times come, extra principal payments. Unfortunately, they they find themselves scrambling to make could not coast on those extra payments, and their mortgage payments. with so many houses on the market for sale, Assume you’re a mortgage banker looking some people literally had to walk away from at your portfolio, and you have 100 loans their home. that are delinquent. All of the loans are The equity these people had worked so hard for homes valued at $300,000. Some of to build up was lost completely. They learned the loan balances are $150,000 and some the hard way that home equity is fragile, and are $250,000. Suddenly, there is a glut in certainly not as safe as they once thought. the market and the homes are now worth Could this happen today? Just look at when $200,000. Which homes do you as the banker foreclose on FIRST? The ones owing the least
amount of money, of course. After all, as a banker you’d make money taking back those homes, however you’d lose money trying to sell a home for $200,000 that still owed $250,000 on it. Banks have been known to call delinquent homeowners with high mortgage balances and offer assistance, “We understand you are going through some tough times, is there anything we can do to help you? We really want you to be able to keep your home.” The last thing they want to do is take back a home that they will lose money reselling. It’s interesting to note, during the Great Depression, the Hilton chain of hotels was deeply affected by the stock market crash and couldn’t make their loan payments. What saved them from financial ruin? They were so leveraged, in other words they owed so much more on their property than it was worth, that the banks couldn’t afford to bother wasting their time foreclosing on it. The Hiltons understood the value of keeping high mortgage balances thereby keeping the risk on the banks. The Houston homeowners would have been better off if they had removed a large portion of their equity and put it in a safe and liquid side fund, accessible in a time of need. Ask yourself, if you owned a $400,000 home during an earthquake in California (and you didn’t have earthquake insurance), would you rather have your equity trapped in the house or in a liquid, safe side fund? If it were trapped in the home, your equity would be lost along with the house.
Separating equity to increase rate of return What do you think the rate of return on home equity was in Seattle for the last 3 years? What about Portland? Careful, this is a trick question. The truth is, it doesn’t matter where you live or how fast the homes are appreciating, the return on home equity is always the same, ZERO. We have a misconception that because
our our home home appreciates, appreciates, oror our our mortgage mortgage balance is going down, that the equity has the home’s appreciation. Therefore, balance is going down, thatTherefore, the equityhome has aa the home’s appreciation. home rate of return. That’s not true. Home equity equity simply sits idle in the home. It does rateequity of return. notintrue. HomeItequity simplyThat’s sits idle the home. does not earn any rate of return. Assume you has NO rate of return. Home values fluctuate rate of Home return.values Assume you hasnot NOearn rateany of return. fluctuate have home $100,000 you due totoamarket conditions, not due the have amarket homeworth worth $100,000 which you due conditions, notwhich due to to the own free and clear. If the home appreciates mortgage balance. Since the equity in the own free and clear. If the home appreciates mortgage balance. Since the equity in the 5%, own an $105,000 at 5%,you you own anasset asset worth $105,000 at home has no relation totoworth the home’s value, home has no relation the home’s value, the end ofofthe year. the end the year. ititisisininnonoway way responsible responsible for for the the home’s home’s appreciation. Therefore, home equity simply appreciation. Therefore, home equity simply Now, assume you had separated the Now, assume you had separated the sits idle in the home. It does not earn any sits idle in the home. Itequity doesand not earn anyrate rate $100,000 $100,000ofofhome homeequity andplaced placed itit in in ofofareturn. Assume you have a home worth return. Assume you have a home worth safe, conservative side account earning a safe, conservative side account earning $100,000 which you free clear. If the 8%. side be worth $100,000 youown ownwould freeand and 8%.Your Yourwhich sideaccount account would beclear. worthIf the home appreciates 5%, you own an $108,000 atatthe end ofofthe You still home appreciates 5%, you ownyear. anasset asset worth $108,000 the end the year. Youworth still own the home, which appreciated 5% $105,000 at the end of the year. own theathome, which appreciated 5% and and $105,000 the end of the year.
money to sit sit idle idle in in the the home. home.To Tobe be money were were left left to fair, you mortgage payment you deductible, the net cost of of the thepayment moneyisisyou fair, you do do have have aa mortgage deductible, the net cost money didn’t have before. However, since interest only 3.6%. This produces a 4.4% positive didn’t have This before. However, since interest only 3.6%. produces a 4.4% positive spread between the cost of money and rates are relative, if we are assuming a rateofof spread betweenif the costassuming of moneyaand rates are relative, we are rate the earnings on that money. return of 8%, we can also assume a strategic the earnings oncan thatalso money. return of 8%, we assume a strategic interest-only mortgage would be available availableatat interest-only mortgage would be The story gets much more more compelling The story gets much compelling 5%. Also, since mortgage interest is 100%tax tax 5%. Also, since mortgage interest is 100% over time, although the mortgage mortgage debt debt over time, although the deductible, the net cost cost of of the the money money isis only only deductible, the net remains constant, through compound remains constant, through compound 3.6%. This produces a 4.4% positive spread 3.6%. Thisthe produces a 4.4%continues positive spread interest, side account account to interest,the thecost side continues to between of money and theThe earnings between the cost of money and the earnings grow at a faster pace each year. grow at a faster pace each year. The on that onearnings that money. money. on $100,000 in year 1 are
earnings on $100,000 in year 1 are $8,000. Then in year year 2, 2, the the 8% 8% earnings earnings $8,000. Thenmuch in The story gets more compelling over The story gets are much more compelling on $108,000 $8,640. In year 3, the theover on $108,000 are $8,640. In year 3, time, although the mortgage mortgage debt remains time, although the debt remains earnings $116,640 at 8% 8% are are $9,331. earnings on on $116,640 at $9,331. constant, through compound interest, the compound interest, Since mortgage debt remains remains the the isisworth Since the thethrough mortgage debt the worth$105,000. $105,000.By Byseparating separatingthe the equity equity constant, account continues to grow grow faster Now, assume you had separated the same, the between the cost cost the you was side account continues to atat aaofoffaster Now, assumeaanew youasset hadwhich separated the side same, the spread spread between the the youcreated created new asset which was also also pace each year. The earnings on $100,000 $100,000 of home equity and placed it in a mortgage money and the on $100,000 able aarate ofofreturn. each year. Theand earnings $100,000 of home andTherefore, placed it in a pace mortgage money the abletotoearn earn rateequity return. Therefore, in year 1 are $8,000. Then inequity year 2, 2, the the 8% 8% safe, conservative side account earning 8%. earnings on the separated equity you earned $8,000 more than you would year 1 are Then in year safe, sidemore account 8%. inearnings on$8,000. the separated youconservative earned $8,000 thanearning you would continues to widen further in the have if the money were left to sit idle earnings on $108,000 are $8,640. In year 3, Your side account would be worth $108,000 continues widen further in the In year 3, have money werebeleft to sit$108,000 idle earnings on to $108,000 are $8,640. Your sideif the account would worth homeowner’s favor every year. If we allow in the home. To be fair, you do have a earnings $116,640 atyear. 8% are $9,331. atatthe end ofof the year. still own everyat Ifare we$9,331. allow inthe the home. To fair, You you thehomeowner’s earnings on on favor $116,640 8% end thebe year. You do stillhave owna the the the home equity to remain remain idle in the thethe home, mortgage payment you didn’t have before. home equity to idle in home, mortgage payment you didn’t have before. Since the mortgage debt remains same, home, which appreciated 5% and is worth the mortgage debt remains the same, home, which appreciated 5% and is worth Since we give up the opportunity to put it to However, since interest rates are relative, we give up the opportunity to the put mortgage it to However,Bysince interest rates relative, spread between the cost cost of of $105,000. the equity you the spread between the mortgage $105,000. By separating separating the are equity you the work allow to grow and andthe compound. if ifwe assuming aarate of of work and and allow itit to grow compound. weare are assuming ratewas ofreturn return of 8%, 8%,to money and the earnings on the separated created a new asset which also able created aalso newassume asset which was also able to money and the earnings on the separated we can aastrategic interestwe can also assumeTherefore, strategic interestequity continues to widen widen further the earn a rate of return. you earned equity continueswould to inin off the earn a mortgage rate of return. Therefore, you atearned Homeowners actuallyfurther be better better off only would 5%. Homeowners would actually be onlymortgage wouldbe beavailable availableat 5%. favor everybackyards year. IfIf we we allow $8,000 more than would if the homeowner’s favor every year. allow $8,000 moremortgage than you youinterest wouldishave the homeowner’s burying in their their than Also, 100% burying money money in backyards than Also,since since mortgage interest ishave 100%iftax tax
homeequity equitytotoremain remainidle idleininthe thehome, home,wewe home giveup updown theopportunity opportunity putsince ittotowork work and paying down theirmortgages, mortgages, money give the totoput itsince and paying their money allow it to grow and compound. buried in the backyard is liquid (assuming allow itintothe grow and compound. buried backyard is liquid (assuming
youcan canfind findit),it),and anditsitssafe safe(assuming (assuming you Homeowners would actually bebetter better off Homeowners would actually be no one else finds it). However, neither no one else finds it). However, neither isis off burying money in their backyards than paying earningamoney arate rateofin ofreturn. return. It’sactually actually losing burying their backyards than paying earning It’s losing down their mortgages, since money buried value due to inflation. Few people today down due theirtomortgages, sincepeople moneytoday buried inin value inflation. Few the backyard is liquid (assuming you can find bury money in the back yard or under their the backyard liquid (assuming you can find bury money inisthe back yard or under their mattresses, because they have confidence it),and anditsitssafe safe (assuming no one elsefinds findsit).it). mattresses, because they have confidence it), (assuming no one else in the banking system. They also understand However, neither earning rate return. in the banking system. They also understand However, neither isisearning a arate ofofreturn. idle moneyloses loses value while invested idle money value while invested It’s actually losing value due to inflation. Few It’s actually losing value due to inflation. Few moneygrows growsand andcompounds. compounds.AsAsAlbert Albert money people todaybury bury moneyininthe theback backyard yard or people Einsteintoday said,“The “Themoney mostpowerful powerful forceininor Einstein said, most force under their mattresses, because they have under their mattresses, because they have theuniverse universe iscompound compound interest.” After all, the is interest.” After all, confidence inbuilt thebanking banking system.They They also confidence in the system. also homes were to house families, not store homes were built to house families, not store understand idle money money losestovalue value while understand idle loses while cash. Investments weremade made storecash. cash. cash. Investments were to store
invested money moneygrows growsand andcompounds. compounds.AsAs invested Albert Einstein said, “The most powerful force Takenfrom fromaadifferent different angle, suppose you Albert Einstein said, “The mostsuppose powerful force Taken angle, you in the the universe is compound interest.” After offered anis investment that couldnever never inwere universe compound interest.” After were offered an investment that could go up in value, but might go down. How all, homes were built to house families, not go in value, might down. How not all, up homes werebutbuilt to go house families, much of it would you want? Hopefully none. storecash. cash. Investments were madetonone. tostore store much of it would you want? Hopefully store Investments were made Yet, thisisishome homeequity. equity.It Ithas hasnonorate rateofof Yet, this cash. cash. return, so it cannot go up in value, but it could return, so it cannot go up in value, but it could go down thereal real estate market Taken from adifferent different angle, suppose you go down ininvalue ififthe estate market Taken from avalue angle, suppose you declines or the homeowner experiences wereoffered offered investmentexperiences thatcould couldnever never declines or the homeowner anan were anan investment that uninsured loss (e.g. an earthquake), disability, goup upininvalue, value, butmight might down.How How much uninsured loss but (e.g. an earthquake), disability, go gogodown. much oraaforeclosure foreclosure or
5%.we It’sgive whatupmakes millionaires, millionaires! $100,000 of equity in of it would you want? Hopefully none. Yet, this TheLet’s home, the “opportunity” to earn a The power of leverage costsayofyou nothadborrowing Learn to be your own banker. By using the your home that could be separated. Current
is home equity. It hasano ratecan of return, so it 5 percent return on the money. Let’s be clear, buying home be a great (employment cost vs.isopportunity cost) principles that banks and credit unions use, mortgage interest 5%, so the cost of that cannot go up in value,thebutwealthy it could gothe down investment. However, buy you can amass a fortune. A bank’s greatest money would be $5,000 per year (100% tax By separating the equity we give it new life. in value if as thelittle realofestate market declines home with their own money as or When homeowners separate equity to assets are its liabilities. You cantosubstantially deductible). Rather than bury the $100,000 We give ourselves the opportunity put it to possible, leaving the majority ofan their cash in the homeowner experiences uninsured reposition it in a liquid, safe,going side to account, your net worth by optimizing the in the backyard, we are put it toa workenhance and earn something on it. Assuming a other investments where it’s liquid, safe, and loss (e.g. an earthquake), disability, or a mortgage payment is created. Theanmortgage assets that you already have. By being your work, or “employ” it. If I were employer, 28 percent tax bracket, the net employment earning a rate of return. One of the biggest foreclosure own banker you can make an extra $1 Million why would I be willing hire an assistant payment is considered the to Employment Cost. cost for is not 5%, but 3.6%, or $3,600 per year misconceptions homeowners have is that their retirement. $35,000 perdon’t year?understand The expectation is I Whatformany people is when home is the best investment they ever made. am going to be able to grow my business after taxes (mortgage interest is 100% tax If you purchased a home in 1990 for $250,000 we leave equity trapped in our home, we incur deductible). It’s not too difficult to find tax and earn a profit on it. As a business owner, to create an extra and sold it in June of 2003 for $600,000, that the same cost, but we call it a lost Opportunity free How or tax deferred investments earning I believe that by investing in an assistant I Let’s be clear, buying a home can be a Cost. represents a gain of 140%. During the same dollars fortaxretirement will earn a return that’s greater than the costmoremillion than 3.6%. Using the benefits of a period, the Dow Jones grew fromthe 2590 to 9188, great investment. However, wealthy of employing that assistant. If we choose to you can create your own arbitrage that’s parked in your home doing mortgage, By repositioning $200,000 into an equity abuy gainthe of 255%. realityashere is that homeThewith little of financing their The money leave the $100,000 of equity in our home, by management borrowing at one rate and earning account with a financial advisor could be put to work earning you your was the investment decision own home money as best possible, leaving the nothing we incur almost the same cost. The only you can achieve gain ofhigher $1 million investment returns ata net a slightly rate. something. that you ever made. When you purchased the majority of their cash in other investments difference is, instead of referring to that cost over thirty years. Assume you separate the It’s what the banks and credit unions do all $250,000 house in 1990, you only put $50,000 employment cost, it is referred to as an where it’s liquid, safe, and earning a rate of Let’sassay $200,000 of home equity using a mortgage you had $100,000 of equity in down. The $50,000 cash investment produced a borrow our money at 2% and opportunity cost. By leaving the equity in thethe time.aThey return. One of the biggest misconceptions 5% interest rate. If the $200,000 profit of $350,000. That is a total return of 600%,your home that could be separated. Current thenwith loan it back to us at 5%. It’s what makes home, we give up the “opportunity” to earn a grows homeowners have is that home is mortgage at a conservative rate of 6.75% per far outpacing the measly 255%their earned by the interest is 5%, so the cost of that millionaires, millionaires! Learn to be your 5 percent return on the money. year, it will be worth $1,419,275 in 30 years. the best investment they ever made. If you money stock market. would be $5,000 per year (100% tax own banker. By using the principles that After deducting the $216,000 in interest purchased a home in 1990 for $250,000 deductible). Ratherthe thanequity bury the $100,000 By separating we give it newinlife. banks and credit unions use, you can amass payments and the $200,000 mortgage, you and sold it inofJune 2003 for $600,000, the backyard, The cost notofborrowing we are going put it to work, or it toa fortune. We give ourselves the to opportunity to put A $1,003,275 bank’s greatest assetsaccount. are itsA still have left in your that represents acost gainvs. of 140%. During cost) the “employ” work it. and on why it. Assuming If Iearn weresomething an employer, would I a liabilities. (employment opportunity net gain over one million enhance dollars. your Youofcan substantially same period, the Dow Jones grew from be willing 28 percent employment to hiretax anbracket, assistantthe fornet $35,000 per net worth by optimizing the assets that you When homeowners separate equity to reposition is not 5%, but 3.6%, or $3,600 per year 2590 to 9188, a gain of 255%. The reality year?cost The expectation is I am going to be able Thishave. example simplyyour shows timeyou already By being owna one banker it in a liquid, safe, side account, a mortgage after taxes (mortgage interest is 100% tax here is that financing your home was the to grow repositioning of equity. Imagine how the my business and earn a profit on it. As an extra $1 Million for retirement. payment is created. The mortgage payment is deductible). It’s not too difficult to find tax can make best investment decision that you ever a business numbers grow for individuals that harvest owner, I believe that by investing in considered the Employment Cost. What many free or tax deferred investments earning and reposition their home equity every 5 made. When you purchased the $250,000 an assistant I will earn a return that’s greater people don’t understand is when we leave more than 3.6%. Using the tax benefits years as their home continues to appreciate! house trapped in 1990,inyou putwe$50,000 down. equity ouronly home, incur the same thanofthe cost of employing that assistant. a mortgage, you can create your ownIf This is how the wealthy manage their home The $50,000 investment produced cost, but we callcash it a lost Opportunity Cost. a we choose to leave the $100,000 equity arbitrage by borrowing at oneofrate and in equity to continually increase their net worth. profit of $350,000. That is a total return of our home, earningweinvestment returns at a slightly incur almost the same cost. The Conversely, if the same $200,000 $200,000 into an were equityleft The money that’s parked in your255% homeearned 600%, far outpacing the measly rate.is, It’sinstead what the andtocredit only higher difference of banks referring that By repositioning to sit idle in the home for 30 years, it would doing could be put to work earning you account with a financial advisor by the nothing stock market. unions do all thecost, time.it They borrow ouran management cost as employment is referred to as not have earned a dime. something. money at 2% and then loan it back to us at you can achieve a net gain of $1 million
The power of leverage
How to create an extra million dollars for retirement
opportunity cost. By leaving the equity in the
“Homes “Homes are are designed designedtotohouse house families,not families,notstore storecash.” cash.” “Investments “Investmentsare aredesigned designed to to store storecash.” cash.” from the NASD: “Brokers are not prohibited Betting theAssume ranch;yourisking 401 vacation condo make the mortgage payments. over thirty years. separatehome the investment client recommendations. This would include from thetoNASD: are not prohibited from making such“Brokers a recommendation per Betting the ranch; risking home 401 vacation condo investment to make the mortgage payments. over thirty years. Assume you separate the client recommendations. This would $200,000 of home equity using a mortgage adequately explaining the risks suchinclude an equity to buy securities Many successful people in the of Northwest from making such a recommendation per se, so long as the investment is reasonably Home equity is Serious Money. We don’t $200,000 of home equity using a mortgage adequately explaining the risks of such equity to buy securities Manyof successful people in athe Northwest with a 5% interest rate. If the $200,000 grows Home which and are significant, to thean dream retiring buying second se, so long as Serious the investment isWe reasonably suitable for isinvestment in general, and it is investment, equity Money. don’t Recently the NASD issued an alert, “… gamble home equity. Liquidity and safety with 5% interest rate.issued Ifofthe6.75% $200,000 growsit investment, whichorsimply are buying significant, to the dream of retiring and second atRecently aa conservative per year, The NASD wants ensure home in Arizona Hawaii. Withato one suitable for the investment in general, it istoinvestor.” the anthat alert, “… for specific customer. order because weNASD arerate concerned investors gamble home equity. Liquidity andInand safety are the key philosophies when separating atwill abecause conservative rate of 6.75% per year, it investor.” The NASD simply wants to home in Arizona or Hawaii. With one million dollars or moreprudent saved inadvice. their ensure be must worth $1,419,275 in that 30returns years. consumers are receiving forsuitability, the specific customer. In order to determine a broker should werely are concerned investors who on investment toAfter are suitable the key philosophies when separating home equity. Rate of return is a distant million dollars or moreto saved their IRA/401Ks, they decide retire in and buy will be must worth $1,419,275 30returns years. are receiving prudent advice. determine suitability, a broker should consider the client’s investment objectives, consumers deducting the $216,000 inininterest payments who rely on investment toAfter make their mortgage payments could end home equity. Rate of return is a distant third benefit. Also, it is not necessary or IRA/401Ks, they decide to retire and buy the vacation home where they will spend consider the client’s investment objectives, deducting themortgage $216,000 inhome interest payments financial status, tax status, and any other make their payments end upthe defaulting on their loans if their and $200,000 mortgage, youcould still have Tax deductions to third benefit. Also, it is not necessary or the vacation home where they will spend their winters. What a surprise when they recommended to invest in highly volatile financial status, status, and any other information a firmtax uses to make suitable upinvestments defaulting on home loans if their and they unable and the $200,000 mortgage, you still have $1,003,275 leftdecline in their your account. Aarenet gain ofto Tax deductions discover that withdrawals toWhat pay to cash for a $350,000 their winters. a surprise when they recommended to invest in highly volatile or aggressive investments. You can make client recommendations. This would include offset information a firm uses to make suitable 401k meet payments.” The investments decline and they A are $1,003,275 leftmonthly indollars. yourmortgage account. netunable gain ofto over onetheir million condo they need to withdraw nearly discover that to pay cash for a or aggressive investments. You can make adequately explaining the risks of such an client recommendations. would include of dollars by simplyThis borrowing at offset 401k withdrawals $350,000 NASD is absolutely correct inpayments.” advising against meet monthly mortgage The thousands over onetheir million dollars. $500,000 from theirto401K/IRA. What if condo they need withdraw nearly successful retirees have the majority investment, which arein significant, the at adequately explaining the oftosuch an Most separating equity ifcorrect the client must on thousands of dollars by simply borrowing 5% and investing at 5% saferisks conservative This example simply shows a onerelytime NASD is absolutely in advising against instead they had purchased the condo $500,000 from their 401K/IRA. What if have equity the majority theirsuccessful assets in retirees their home and investor.” Thewhich NASD simply to ensure the returnsequity from their investment to make investment, are togoing the ofMost separating if the client must rely on investing at 5% insignificant, safewants conservative This example simply shows a one time fixedand investments without ever repositioning of equity. Imagine how thethe 5% 15 years earlier, when it cost $175,000, by they had purchased condo consumersThe areNASD prudent advice. mortgage payments. As they withdrawing fundsand of instead their assets instart their hometheequity simply wants togoing ensureIRA/401Ks. the returns from their investment make into investor.” securities. Inreceiving general, individuals numbers grow individuals harvest investments without ever repositioning of for equity. Imaginethatto how thethe fixed using the equity inwhen their home? 15 years earlier, it cost $175,000, Home equity is Serious Money. We don’t consumers arehome prudent advice. from their IRA/401Ks, theywithdrawing are hit withfunds aby mortgage payments. IRA/401Ks. As they start should not invest equity forindividuals “current and reposition their home equity securities. Inreceiving general, numbers grow for individuals that every harvest5 into using the equity in their home? gamble home Liquidity and safety Home equity is equity. Serious Money. don’t are income” annual tax bill. they Moreover, the with kids a Taxnotdeductions to offset from their are$175,000 hit unless investment fixed significant years askey their home continues to We appreciate! investthe home equity foris“current and reposition their home every 5 should Today theirIRA/401Ks, net worth would be the philosophies whenequity gamble home equity. Liquidity and safety are movedannual out, the thetax mortgage is paid,the and significant bill.would Moreover, kids deductions to interested offset 401k withdrawals and Tax guaranteed. Individuals in have Thisseparating is how wealthy manage their home income” higher, condo’s appreciation, unless the investment is fixed years as theirthe home continues toofappreciate! Todaydue theirtonet worth be $175,000 home equity. Rate return the key philosophies when tax deductible contributions to 401Ks have moved out, thecondo’s mortgage is paid, and and they due would the mortgage variable investments should have askinterested themselves, equity to continually increase their net 401k withdrawals guaranteed. Individuals in have This the wealthy manage home and higher, to have the appreciation, isisahow distant third benefit. Also, ittheir is notworth. Most successful retirees the majority separating home equity. Rate of return stopped. When they could use the mortgage interest deduction to help off-set their have deductible contributions to 401Ks “Howof will I assets make inmytheir mortgage payment if tax and Conversely, ifthird therecommended same $200,000 were left they would have the mortgage or to in to variable their home investments should askequity themselves, equity to continually increase their net isnecessary a distant benefit. Also, it isinvest notworth. Most successful retirees have the and majority interest IRA/401K withdrawals. In addition tomortgage the deduction the could most, they don’t have When they use the highly or aggressive investments. interest deduction to help off-set their my investments Do I have reserve sitnecessary idle involatile the home for$200,000 30 years, itinvest would IRA/401Ks. Asdecline? they start withdrawing funds will make mytheir mortgage payment if stopped. Conversely, if or the same were left to “How recommended to innot of theirI assets in home equity and financial advantages, they would have it. As part of long term planning, someone You of dollars by simply funds IRA/401K withdrawals. In addition to the from IRA/401Ks, they are hit with a deduction the most, they don’t have or their a secure income?” InI have April 2004, earned a dime. highly volatile orthousands aggressive investments. Dowithdrawing reserve sithave idle incan themake home for 30 years, it would not my investments IRA/401Ks. Asdecline? they start funds interest enjoyed the lifestyle benefits of may owning who is preparing for retirement want borrowing at 5% and investing at 5% in safe the significant financial advantages, they would have annual tax bill. Moreover, the kids it.their As part of long term planning, someone following question was posed to2004, the You can make thousands of dollars by simply funds from IRA/401Ks, they are hit with a or their a secure income?” In April have earned a dime. vacation condo 15 years sooner conservative fixed investments without ever NASD, have a mortgage going into retirement have moved out, the mortgage is paid, and towho enjoyed the lifestyle benefits of owning “Where can I find the exact language is preparing borrowing at 5% and investing at 5% in safe the significant annual tax bill. they planned.for retirement may want following question wasMoreover, posed tothe thekids than Betting the ranch; going into securities. Inrisking general, individuals tax deductible contributions to 401Ks have theiroffset vacation 15IRA/401k years sooner the condo annual tax bill conservative fixed investments without ever NASD, thatandtotohelp prohibiting a broker from have a mortgage going into retirement have moved out, the recommending mortgage is paid, “Where can Ithey find the exact language shouldequity not invest home equity for “current stopped. When could use the mortgage than they planned. and enhance their overall financial home to buy securities Betting thesecurities. ranch;Inrisking going into general, individuals I taketax deductibleout 401Ks have to help offset the annual IRA/401k goals. a mortgage onthemy housetoand invest tax bill income” unless the investment is fixed sam your prohibiting brokercontributions from recommending interest adeduction most, they don’tthat haveFor Making many, the uncle mortgage interest deduction shouldequity not invest home equity for “current stopped. When they could use the mortgage the money in securities?” The written answer and enhance their overall financial goals. home to buy securities and guaranteed. Individuals interested in it.aAs part of long planning, someone Recently the NASD issued an alert, “…because I takeinterest mortgage outterm onthemy house and invest best partner offsets taxes due on retirement withdrawals, income” unless the investment is fixed Making uncle sam your deduction most, they don’t have from the NASD: “Brokers are not prohibited variable investments should ask For many, the mortgage interest deduction who is preparing for retirement mayanswer want we areguaranteed. concerned that investors whothemselves, must in rely the money in of securities?” The written and Individuals interested giving thetax net effect of tax free withdrawals it. making As part longa term planning, someone Recently the NASD issued an alert, “…because Under law deduct upwithdrawals, to one best partner from such recommendation per “How will I make my mortgage payment if to have a mortgage going into retirement offsets taxes dueyouoncan retirement onvariable investment returns toshould make their mortgage fromwho the NASD: “Brokers are not prohibited investments ask themselves, is preparing for retirement may want their dollars retirement account. interest subject million of mortgage we are that investors must rely se, so myconcerned investments decline? Dowho I have reserve to help offset the annual IRA/401k tax bill from long as the investment is reasonably thetax netlaweffect tax free withdrawals payments could end up defaulting on their you of can deduct up deduct to one fromto making such a recommendation per giving myincome?” payment if a mortgage goingfinancial into retirement toUnder income restrictions. You can also fundswill or Iamake secure In April 2004, on “How investment returns tomortgage make their mortgage andhave enhance their overall goals. suitable for investment in general, and it is from their retirement account. million dollars of mortgage interest subject home loans if their investments decline my decline?was Doposed I haveto reserve se, so to offset the annualinterest IRA/401k tax bill long asthe themortgage investment is reasonably an additional $100,000 from home equity theinvestments following question Forhelp many, deduction payments could end up defaulting on the their suitable for the specific customer. In order to income restrictions. You can also deduct 401 vacation condo funds or “Where a secure income?” Aprilmonthly 2004, and they are unable meet and enhance theironoverall financial loan interest. To take advantage of these suitable fortaxes investment in general, andgoals. it is NASD, can Itoinvestments find theIntheir exact language offsets due retirement withdrawals, home loans if their decline to determine suitability, a broker should an additional $100,000 home equity the following was posed to the that suitable For many, thespecific mortgage deduction mortgage payments.” NASD is absolutely deductions, make sure to from secure a large prohibiting aquestion brokerThe from recommending giving net effect ofcustomer. taxinterest free withdrawals forthethe In order Many 401 vacation condo successful people in the Northwest and they are unable to meet their monthly consider the client’s investment objectives, loan interest. To take advantage of these NASD, “Where can I find the exact language mortgage when you buy. Under tax law, offsets taxes due on account retirement correct against separating if to determine I takeinaadvising mortgage out on my houseequity and invest from their retirement . withdrawals, suitability, a and broker should dream of retiring and buying a second mortgage payments.” The NASD is absolutely deductions, make sure to secure a large financial status, tax status, any other prohibiting ainbroker recommending that mortgage interestpeople is deductible only for giving the net effect of tax free withdrawals Many the money securities?” The written the client must rely onfrom the returns from answer their successful inUnder the Northwest consider the client’s investment objectives, home in Arizona or Hawaii. With one million mortgage when you buy. tax law, correct against separating if information firm uses account to make I takeinaadvising mortgage out on my houseequity and invest from theira retirement . suitable dream of retiring and buying a second financial status, tax status, and any other mortgage interest is deductible only for money securities?” The written thethe client mustinrely on the returns from answer their information a firm uses to make suitable home in Arizona or Hawaii. With one million
dollars dollars or more or more saved saved in their in their IRA/401Ks, IRA/401Ks, theytheyvehicles. vehicles. TaxTax favored favored safesafe investments investments areareknowledge, knowledge, theythey planplan to keep to keep thethe mortgage mortgage decide decide to retire to retire andand buybuy thethe vacation vacation home homeideal. ideal.YouYoushould shouldconsult consultyouryourfinancial financialwellwell intointo retirement retirement so so theythey cancan keep keep thethe where where theythey willwill spend spend their their winters. winters. What What a aplanner plannerfor forthethebestbestinvestment investmentvehicles vehiclestax tax deduction deduction benefits benefits andand keep keep thethe money money surprise surprise when when theythey discover discover thatthat to pay to pay cashcashfor for youryour specific specific situation. situation. Many Many financial financialin in thethe investment investment account account where where it’s it’s more more for for a $350,000 a $350,000 condo condo theythey need need to withdraw to withdrawplanners planners prefer prefer thethe following following tax tax favored favoredliquid, liquid, more more safe, safe, andand willwill continue continue to grow to grow nearly nearly $500,000 $500,000 from from their their 401K/IRA. 401K/IRA. What Whatproducts products for for investing investing home home equity: equity: andand compound. compound. if instead if instead theythey hadhad purchased purchased thethe condo condo 15 15• Investment • Investment grade grade insurance insurance contracts contracts years years earlier, earlier, when when it cost it cost $175,000, $175,000, by using by using • Annuities • Annuities Case Case study: study: thethe equity equity in their in their home? home? • Real • Real estate estate investment investment trusts trusts cash cash flow flow management management Today Today their their netnet worth worth would would be be $175,000 $175,000• IRAS • IRAS It’s It’s notnot necessary necessary to have to have a large a large chunk chunk of of higher, higher,duedueto tothethecondo’s condo’sappreciation, appreciation, • 401ks • 401ks equity equity in your in your home home to benefit to benefit from from using using andand theythey would would have have thethe mortgage mortgage interest interest youryourmortgage mortgageto tocreate createwealth. wealth.Many Many • Tax-free bonds bonds deduction deductionto tohelphelpoff-set off-settheir theirIRA/401K IRA/401K• Tax-free homeowners homeowners without without a large a large equity equity balance balance withdrawals. withdrawals.In Inaddition additionto tothethefinancial financial• 529 • 529 savings savings planplan have have benefited benefited by by simply simply moving moving to atomore a more advantages, advantages, theythey would would have have enjoyed enjoyed thethe strategic strategic mortgage mortgage which which allows allows them them to pay to pay lifestyle lifestyle benefits benefits of of owning owning their their vacation vacation Case Case study: study: less less to their to their mortgage mortgage company company each each month, month, condo condo 15 15 years years sooner sooner than than theythey planned. planned. thereby thereby enabling enabling them them to to savesave or or invest invest home home equity equity management management Making Making uncle uncle samsam youryour bestbest partner partner Under Under more more each each month. month. ForFor example, example, a couple a couple in in There’s a recent a recent casecase study study of aofcouple a couple living livingRedmond, tax tax lawlaw youyou cancan deduct deduct up up to to oneone million millionThere’s Redmond, Washington Washington followed followed traditional traditional a $550,000 home home in Bellevue, in Bellevue, WA.WA. They Theythinking dollars dollars of mortgage of mortgage interest interest subject subject to income to incomein ain$550,000 thinking when when theythey bought bought their their $400,000 $400,000 owed $360,000 $360,000 on on a 30-year a 30-year fixed fixed mortgage mortgagehome. restrictions. restrictions. YouYou cancan alsoalso deduct deduct an additional an additionalowed home. They They putput 20%20% down down andand obtained obtained a a at 5.875% withwith a monthly a monthly payment payment of $2,130. of $2,130.$320,000 $100,000 $100,000 from from home home equity equity loanloan interest. interest. To Toat 5.875% $320,000 30-year 30-year fixed fixed raterate mortgage mortgage at at They hadhad $190,000 $190,000 built built up up in home in home equity. equity.6.00% taketake advantage advantage of of these these deductions, deductions, make makeThey 6.00% withwith a payment a payment of $1,919 of $1,919 perper month. month. A very A very common common “Brother “Brother A”-type A”-type traditional traditional suresure to secure to secure a large a large mortgage mortgage when when youyou ThisThis is how is how thethe vastvast majority majority of Americans of Americans scenario. After After understanding understanding thethe liquidity, liquidity,would buy.buy. Under Under tax tax law,law, mortgage mortgage interest interest is isscenario. would purchase purchase thisthis home. home. safety, safety, rate rate of of return, return, and and tax tax benefits benefits of of deductible deductible onlyonly for for $100,000 $100,000 overover acquisition acquisition However, once once thisthis couple couple understood understood thethe properly managing managing their their home home equity, equity, thisthisHowever, indebtedness indebtedness (the(the mortgage mortgage balance balance when whenproperly benefits benefits of of integrating integrating their their mortgage mortgage into into coupledecided decidedto toseparate separate$155,800 $155,800of of home home is purchased). is purchased). Home Home improvements improvementscouple their financial financial plan, plan, theythey decided decided to to make make their equity equity to invest to invest in ainsafe a safe conservative conservativetheir areare thethe onlyonly exception. exception. ForFor example, example, if you if youtheir a change. a change. They They moved moved to to a more a more strategic strategic account. account. By By using using an an interest-only interest-only ARM ARM sellsell youryour home home for for $400,000 $400,000 andand buybuy a new a newsideside interest-only interest-only mortgage. mortgage. They They keptkept thethe same same they they were were able able to to increase increase their their mortgage mortgage home home for for $400,000 $400,000 withwith thethe cashcash from from thethe loan loan balance, balance, but but were were able able to reduce to reduce their their balance to separate to separate thisthis chunk chunk of equity of equity while while sale, sale, youyou willwill loselose thethe tax tax break break andand liquidity. liquidity.balance monthly payments payments to to $1,133 $1,133 perper month, month, decreasing their their monthly monthly mortgage mortgage payment paymentmonthly ButBut worse, worse, if you if you laterlater decide decide to take to take outout a adecreasing a savings of of $786 $786 perper month month from from their their $1,656, $1,656, a monthly a monthly cashcash flowflow savings savings of ofa savings home home equity equity loan, loan, onlyonly thethe firstfirst $100,000 $100,000 willwillto to previous previous mortgage. mortgage. The The couple couple invests invests the the $474 $474 per per month. month. be tax be tax deductible. deductible. Instead, Instead, secure secure a $360,000 a $360,000 $786 $786 savings savings each each month, month, andand assuming assuming mortgage mortgage (90%) (90%) when when youyou buybuy thethe home home andand TheThecouple coupleconservatively conservativelyinvested investedthethea 6% a 6% rate rate of return, of return, they they will will have have enough enough thethe entire entire amount amount is deductible. is deductible. $155,800 $155,800lump lumpsumsumandandthethe$474 $474perpermoney money in their in their investment investment account account to pay to pay off off month month savings savings withwith their their financial financial planner. planner.their their mortgage mortgage in 19 in 19 years years (11(11 years years sooner sooner If we If we assume assume a conservative a conservative 6%6% raterate of ofthan Where Where to to safely safely invest invest thantheir theirprevious previous30 30yearyearschedule!). schedule!). return, return, their their investment investment account account will will grow grow to toTherefore, Therefore, by by simply simply redirecting redirecting a portion a portion of of home home equity equity $520,196 $520,196 in 15 in 15 years. years. In the In the 15th 15th year, year, theytheytheir their monthly monthly mortgage mortgage payment, payment, theythey were were Home Homeequity equityis isserious seriousmoney. money.WeWearearewillwill have have enough enough cashcash in in their their investment investmentableable to potentially to potentially shave shave 11 11 years years off off their their separating separating it from it from thethe home home to conserve to conserve it, it,account account to pay to pay off off their their mortgage mortgage completely completelymortgage. mortgage. In addition, In addition, theythey alsoalso received received thethe notnot to consume to consume it. Therefore it. Therefore it should it should notnot be beif they if they want want to to (15(15 years years earlier earlier than than withwithbenefits benefits of having of having their their cashcash in ainmore a more liquid, liquid, invested invested aggressively. aggressively. Rather, Rather, home home equity equity is istheir their original original 30 30 yearyear mortgage!). mortgage!). However, However,more more safesafe position position throughout throughout thethe process. process. bestbest invested invested in safe, in safe, conservative conservative investment investmentarmed armed withwith their their newnew equity equity management management
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