Managing home equity

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DeathFalcon
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Managing home equity

Post by DeathFalcon » Wed Oct 11, 2017 2:07 pm

A college friend is currently taking his MBA and was given this as part of his course. I'm curious to read thoughts here from a boglehead's perspective

http://www.clevelandhousingmarket.com/i ... NotBad.pdf

runner540
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Joined: Sun Feb 26, 2017 5:43 pm

Re: Managing home equity

Post by runner540 » Wed Oct 11, 2017 2:33 pm

I'll bite:
1. This looks like an old article (2004?)
2. It says that the alternative to home equity is a "safe, conservative side account earning 8%" (!!!!) while an interest only mortgage is at 5%. After taxes, the hypothetical spread is 4.4%. (Page 9)
That is just not reality right now. If there were a risk free 4% arbitrage opportunity, BH's would be all over it.
3. My takeaway is that the article is actually advocating for a healthy emergency fund/liquidity, which is consistent with Boglehead principles. Don't pay down your mortgage if it means erasing your liquidity. Don't buy a house so expensive that you can't make mortgage payments AND invest.

Edit: the article is also suggesting you give your funds to the firm to manage and get that 8% safe return :greedy

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Meg77
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Re: Managing home equity

Post by Meg77 » Wed Oct 11, 2017 4:40 pm

I didn't read the entire article, but it seems to boil down to the following: borrow as much as you can against your home and invest it. You'll make more than the cost of the loan and end up better of than having simply paid off the mortgage.

This isn't a new or complicated idea, despite the tone and length of the paper. Leverage is very powerful, but it's powerful in both directions. It can certainly enhance your returns and net worth when the investment performs. But if the investment loses money, your losses are also magnified.
"An investment in knowledge pays the best interest." - Benjamin Franklin

CurlyDave
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Re: Managing home equity

Post by CurlyDave » Thu Oct 12, 2017 7:12 am

I have done much of what the paper recommends, and it has worked out well for me.

Even in retirement DW and I have well over $1M in total mortgages on our primary residence and various investment properties. And, it does not bother us in the slightest, because we have used the equity to invest in areas which produce income streams that more than cover the mortgages. While a 50% market correction coupled with a 50% rental vacancy rate would not be fun, we would survive it.

During our accumulation phase, before every mortgage and before every refinance, I have always done a contingency analysis on the outcome if two unlikely events both happened: loss of a job, 50 % market decline, long-term disability, years-long vacancy in a rental. If I could see how we would make the necessary adjustments to our lifestyle to make it through any two of these without financial disaster I would go ahead. If not, I wouldn't. In retirement, we have changed our investment profile from single family houses, to multi family buildings, which are even less liquid than SFH.

With 20/20 hindsight, we could have been much more prosperous if I had been willing to take more risks. OTOH, we personally know people who have taken higher risks and failed, so we are happy with the course we traveled.

I still feel paying off a mortgage early is never a good idea. As the article points out, that money can be better invested in other ways and liquidity is very, very valuable. Plus, contingency analysis has always shown me that it is far more risky to partially pay off a mortgage than to invest that extra money. While the article points out that "cash is king", it doesn't really emphasize enough that a mortgage is the "king of debt". If I keep up the payments, the loan can not be called, no matter what changes in my credit rating, or housing market declines, happen. OTOH, if I pay off part of a mortgage (which includes extra payments) the mortgage holder will show no mercy if I fall on hard times.

stan1
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Re: Managing home equity

Post by stan1 » Thu Oct 12, 2017 7:42 am

"Most people" do not have the business acumen to manage their personal finances and home equity like an investment bank/hedge fund even if they had the desire. In 2016 there were over 819,000 bankruptcies in the U.S. (source: uscourts.gov). Just because you can doesn't mean you should.

curmudgeon
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Re: Managing home equity

Post by curmudgeon » Thu Oct 12, 2017 10:41 am

I have personally known folks who did this type of thing and ended up losing their home to foreclosure. Very destructive to their personal wealth. The temptation to spend some of that equity rather than invest it is also an issue. High leverage is a major factor in many failures, business and personal.

That said, during my working years I consciously chose to invest some of my extra cash flow rather than use all of it to pay down the mortgage faster. I also invested 100% in equities. I had time and income streams to enable me to ride out the storms, and I was willing to take moderate additional risk to gain higher returns. Now that I'm retired, I've chosen to dial down the risk. I paid off the last mortgage; even though it was at a low rate, I couldn't get equivalent returns from safe bonds and I'm managing by taxable income for ACA subsidies. I've also moved my investment risk profile down a notch, holding bonds/CDs. I'm still probably on the higher risk side of the spectrum (especially for bogleheads), but without a base income I have no desire to be leveraged.

ResearchMed
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Re: Managing home equity

Post by ResearchMed » Thu Oct 12, 2017 11:20 am

stan1 wrote:
Thu Oct 12, 2017 7:42 am
"Most people" do not have the business acumen to manage their personal finances and home equity like an investment bank/hedge fund even if they had the desire. In 2016 there were over 819,000 bankruptcies in the U.S. (source: uscourts.gov). Just because you can doesn't mean you should.
Is there any evidence that many/most of these bankruptcies were due to poor management of "personal finances and home equity like an investment bank/hedge fund"?
[emphasis added]

Apparently things like job loss and extraordinary medical expenses are causes for many/most bankruptcies, without those people trying to act like "investment bank/hedge funds" in their management of their primary residential equity.

Don't forget how little money "most" people in the USA have been able to save, many with virtually no serious savings even for emergencies.
IF they leveraged up their primary residences, for "most people" it probably wasn't to improve their investment portfolios... but to make car payments, buy groceries, pay for medical care, or even, yes, pay those [now higher] mortgages.

RM
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