The economy sucks. We’re bombarded by media trash everyday about the soft economy, the continued job losses, and how bankruptcy is the new fashion trend for large corporations. However, those of you who still have jobs are still wondering when the economy will turn around. Let’s be real, though. Whether the economy trends up or down, if you’re still employed, nothing changes for the majority of people. Unless you have your millions stashed in the stock market, it really doesn’t affect you all that much, now does it? I know I don’t have my billions in the stock market, either…I think I just misplaced them at some point.
The real estate market seems to be all the rage with local news media these days. The “soft market” is riddled with horror stories of people not being able to sell their homes, being forced into foreclosure or worse. This brings me to the point of today’s article: your home is not an asset unless you separate the equity away from the house. Allow me to explain.
Your home is a great place to house your family, not your finances. Millions of people make the mistake of purchasing a home and pouring all of their extra money into paying off the mortgage. Big mistake! First of all, the interest paid on a mortgage is generally tax-deductible. If you pay off the mortgage, you will lose that tax shelter and thus increase your tax liability. Secondly, if you pour hundreds of extra dollars into paying off the mortgage loan, how much of a return do you generate in the process? We know that the debt incurred by the loan is decreasing, and the value of the home will generally increase, or appreciate in value over time, but how much of a return is there for paying more into your mortgage? NOTHING! ZIP! ZERO! NADA!
The mortgage company pays you zero interest on all of that money that you are paying them above and beyond the loan requirements each month. You would be better off paying yourself that extra few hundred dollars each month into a side fund that could earn an interest rate (make your money work for you, not against you).
The second concept I would like to bring up is one that I hinted at earlier: separating the equity from your home. How do you do that? Refinancing. The term “refinancing” brings forth negative feelings for most people, since you normally only heard of people refinancing their homes in tough times for the extra money. Allow me to introduce a new concept to you: refinance for profit. You should really try to refinance your home every two to four years as it appreciates in value to free up that equity into a liquid side fund where it can earn interest. I’ll give you an example.
Say you purchased your home for $100,000 four years ago with a mortgage charging 6% interest, and have been socking away money into that mortgage every month since in a futile attempt to reduce your debt. Perhaps your current mortgage debt is $90,000 (to keep the math easy). However, over the last four years, and with some property improvements here and there, your home has appreciated to $140,000. Great! But what good is that unless that extra equity is earning you more money?
The smart thing to do would be to refinance your home, often at a much better interest rate (but for the example we will stick with 6%). So say you refinance your home for $140k. That leaves you $50,000 after you pay the previous mortgage off. What should you do with that money? Buy a boat? A new car? Take a vacation with it? Absolutely not. You should put that money into an account where it can earn an average of 9-15% interest every year (indexed universal life insurance contracts are a great means of doing this – for more information I recommend the book Millionaire by Thirty by Douglas Andrew and his sons).
But wait, you are paying interest on that mortgage, aren’t you? Of course. We said it was 6%, right? So if you are earning between 9 and 15% interest on the side with that $50k, and are paying out 6% on the loan, you are still profiting between 3 and 9% interest (even more if you consider the tax advantages of deducting the mortgage interest). This technique is called arbitrage – you earn a higher interest rate than you are paying out, thus profiting the difference. This is what banks and credit unions do to make their millions. You would normally put your money in a bank to earn a pathetic interest rate, meanwhile they loan out your money at a much higher interest rate to amass a huge profit! So in this sense, you are becoming your own banker by separating the equity away from your house so that you can make a profit.
You should refinance your home every few years once it gets up over the $30k point in appreciated value, and add this money to your nest egg. If you want to fast track your way to an early retirement, consider doing this with a multitude of properties. Buy a few rental homes so that the mortgage and repairs are covered, and reallocate the equity into your nest egg to earn you compounding interest. Keep doing this, and you’ll be a millionaire before you know it.
Shaun,
ReplyDeleteThe number one misnomer that lead to the housing crash was the assumption that home values generally appreciate.
In fact, there is deflationary pressure on the general market for the near future.
It's a very dangerous suggestion.
Just my two cents.
The real estate market will indeed have its soft areas, as well as weak times, however I must point to the biology of the planet. The population will continue to increase (America breeds like rabbits) and there is only a set amount of land of which can be distributed among the people. Supply and demand thus suggests that over time, although it will have its ups and downs, real estate will generally continue to appreciate. It would be nearly impossible to prevent the natural fluctuations of the market, whether in a positive or negative direction, indefinitely. I agree that there is a deflationary pressure on the market for the near future. In my opinion, this translates to houses being on sale. ;)
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