What if I were to tell you that almost everything you have been told about what to do with your home has been absolutely wrong and that one of the worst ways to build wealth is through your home? And what if I further went on to show you that anyone who perpetuates this myth probably is not your best source for accurate financial information?
Most of you right now are looking at the byline a couple of times to see if this article is REALLY being written by a mortgage person. Some of you have taken this as final, unequivocal proof that all mortgage people really do sit around a big table of tea cups wearing hats with fractions on them! No you are not in Wonderland but if you keep reading you might find many of you have been for a long time now.
One of the buzzwords or catch phrases floating around the financial circles is "wealth creation." This has gained prominence due to the ability of the planner or agent to broaden their focus on overall wealth with their clients instead of just return on a particular investment. While a holistic approach is a very good one, what wealth creation strategies often lack are a defined strategy for accomplishing well, wealth creation! These plans often fail or vastly under perform because they don't properly account for one of the biggest parts of the wealth picture and that's the home!
WHAT DID HE SAY?
Now that's not a typo and I didn't contradict myself from the first paragraph. You see, most people believe their home is something completely separate from the rest of their financial planning. It's this sacred cow that's over in the green grass munching away while everything else in their financial life is trying to figure out how to grow without the food it needs. The sooner people realize that EVERYTHING they do is an investment decision , the better off they will be. The implication of your decision is not simply what you obtain by your action but what opportunity you give up.
So, back to wealth creation and mortgage planning. In borrowing some thoughts from a great financial partner of mine, Brent Gilmore, we can summarize what we typically look for as far as characteristics of a good investment as:
• something that earns us a good return based on our risk
• is liquid if we need it
• is not subject to additional restriction to access it once we have it
• is not at risk of loss.
The reality is your home is absolutely not the definition of a good investment. The reasons are fairly clear if we break them down. What if I told you the MAXIMUM return you could make on the purchase of your home was 0%?
Here's where we hit the rabbit hole.
First we must explain the difference between return of investment and return on investment. Return OF investment is simply getting back the money that you put in. Return ON investment is difference between the end value of your investment and the amount you invested.
Whether you pay cash for your home or pay nothing down, your home mortgage will be worth the exact same in 1 year, 5 years, 10 years or 30 years. It is true that if values keep going up you will make a positive return ON investment but that is independent of the return OF your investment. Even that fact has some doubt clouding it, but that's another article.
PAGING CHICKEN LITTLE
Now let's step back from all of the sky is falling stuff and clear some things up. Your house may well continue to appreciate in value, especially in a strong local economy like Columbus . But appreciation as I showed you above has absolutely nothing to do with return OF capital . Remember that if you bought a $300,000 house today, paid cash for it and turned around in 1 year and sold it for $350,000 you would have experienced the same appreciation as if you had put $0 down to buy the house. Your $300,000 was invested in an asset that yielded 0% during its use.
The key to this is that when you pay your mortgage you "choose" to invest the money in your home instead of in other options that could return you more . Lets Consider the consequences of not being able to pay that mortgage one day:
• Will the bank give you back the money you paid on the mortgage and all of the appreciation when they sell your house in foreclosure?
• Will they lend you more to help you get back on your feet at terms as good or better then you have now?
• And will they do it without asking you to prove your ability to repay the new loan when you couldn't pay the old one?
Sounds silly, but this is what happens all the time.
Now wait, you say, I have a paper that shows me that if I pay twice per month I will pay off my mortgage 8 years sooner and save $84,000 in interest! You are right, you will. BUT is it a good choice if that money that you borrowed at 4% (After factoring in tax savings on the interest) could be returning you more, guaranteed , elsewhere? Consider other factors as well:
• Are you making those payments and carrying "bad" debt like credit cards at 15%?
• Are you finding it hard to put in enough in your 401k to even get the match your employer offers?
• Are you funding the Roth IRA or the kids 529 college savings plan?
We aren't even touching on the implications of eliminating or reducing your tax deduction and increasing your overall tax burden.
TO PAY OFF OR NOT TO PAY OFF , THAT IS THE QUESTION
Let's look at the positive outcomes of paying off your mortgage versus keeping it.
You no longer have to make a mortgage payment to the bank every month.
You might have less to pay at retirement. And that's about it. Now, notice I didn't say anything about the myth that you finally "own" your home. In truth you never do, you always have to pay taxes on it and it is always at risk of loss through various means including but not limited to:
• Casualty Loss
In just about any analysis where someone is using the money that they would otherwise use to pay down the principal of their mortgage for other means of wealth creation, the other 'means' come out ahead every time. The requirement here is to spurn our human instinct to consume and to use this money effectively.
Notice that this is the key to wealth creation. If you can't conquer that human instinct nothing else matters. What this allows you to do is to use dollars you are already spending and inject them into the system to your advantage.
The simple truth is that paying off your mortgage is purely an emotional decision that we have been trained to believe is what we are supposed to do, but if you understand the implications of the decision and can act accordingly, that choice is usually incorrect.
DON'T PAY ATTENTION TO THE MAN BEHIND THE CURTAIN
Now you say, this is just a clever trick by another mortgage guy trying to make money off of me. Well, typically consumers refinance every 3 years and many times that is because they need money . But clients who have invested that money into the other elements of their financial plan are much less likely to refinance for need reasons.
People borrow for car expenditures, home improvements, college expenses, trips or to pay off that credit card debt they said they would never run up again. People who are planning for these expenses and finding tax preferred or tax free ways to fund them with the money tied up in their home have little need to make decisions based on these "needs".
OK, GREAT . NOW WHAT
There are all kinds of different mortgage products and programs that can make a consumer's head spin. The important thing to keep in mind is that most of them are wrong on almost all levels. If you are looking for wealth creation a home is a great part of that plan if used correctly. That does NOT mean you go out a get an interest only ARM so you can buy a $400,000 house when you otherwise could only afford a $200,000 house.
For many families they want to invest in the college savings. They want to have more than $50,000 in life insurance that their employer gives them. They want to protect against disability or job loss. They want so many things but don't know how to find it in the pool of money that they currently have available. Does it mean they give up? Often, that is the case but it doesn't have to be.
It means that you look at opportunities in the equity that isn't doing anything for you now and put it to use along with reallocating dollars you are already spending. The mortgage vehicle you use is independent of this choice and only your situation will determine which one is best for you. For most this is all that is necessary to see a million dollar or more difference at retirement. For others who are closer to an age where you will cease to earn income it is necessary to change current spending habits along with these measures.
These ideas that I have very briefly touched on are ones that need to be explored on an individual and ongoing basis with a team of financial professionals who understand how to help make this work for you. This is not one of those "plans" with steps that you can follow from a book on your own and in 20 years a golden goose lays you some precious eggs. Coordinating 401(k), Roth IRA, investments, permanent life insurance, wills and trusts is something that needs much more discussion than is prudent here and frankly with people who are much more qualified to tell you than me.
It is time to think of your mortgage and your home as more than the place where you and your family make great memories. If you allow it to work as part of a total responsible financial philosophy it can be an incredible wealth booster. With so many choices in all areas of finance it is imperative that you find a group of professionals that hold those same beliefs and values. Easier said than done, I know. I know because that is exactly what we have been doing for over a year in Columbus exclusively for our clients.
This, admittedly, is not for everyone and some of you might have even stopped reading by now because you think I am obviously out of my mind. That's ok, because changing that human instinct to hurry up and pay down a mortgage is difficult. But for those of you who have had their eyes opened, hopefully I have provided you with enough food for thought that you're starting to reconsider how your mortgage is working for you.
Jeff Blovits is the branch manager of the Westerville Franklin Bank, a mortgage franchise location of the publically traded ssb out of Texas. Jeff has been in the financial services industry for 12 years as bank manager, underwriter, and mortgage lender. His innovative mortgage planning concepts are paving the way for countless clients to improve their financial lives.