More Equity In Your Home EQUALS Increased Risk of Foreclosure

You are probably thinking “Hmm, the more equity I have the more I am at risk for foreclosure, that doesn't sound right?” It is very counter-intuitive, it goes against what your parents and grandparents told you. You know that “Depression Era Thinking” of always put as much money down and pay that loan off as fast as you can so the bank can’t take the house back and you don’t pay that mean old bank back all that interest.

Unfortunately, the advice we got from mom & dad, grandma and grandpa was wrong.  It wasn't always wrong, in fact before 1933 it was great advice, but since 1933 is has been bad advice.  Another fact is as you pay down your house you increase your risk of foreclosure.  Yep, that's right, the more you pay down on your house the MORE RISK you have for getting foreclosed on.

It is our contention that equity in the home earns a zero percent rate of return, so having equity in your home means that you have lazy idle dollars that aren’t very liquid, not necessarily safe and earning a zero percent rate of return- why would you want to have any dollars in that type of account? What we have found is that once you put money into your house- whether it be as a down payment, principal payments or additional principal payments you have accomplished three things:

1. You reduced the amount to pay off the house.
2. You converted interest-earning dollars that were liquid into non-interest earning dollars that are now basically illiquid.
3. You have shifted more risk to you and away from the bank.

None of these are good things for you, it is imperative that you remember that anytime you pay down principal you are increasing your risk (or how much skin you have in the game) and decreasing the risk to the bank. The more equity you have the more likely the bank will lose NOTHING if they have to foreclose. You have much more to lose in that situation.

Put yourself in the banks shoes. Someone wants to borrow money to buy a home from you. If they wanted to buy a $100,000 house and had $50,000 to put down, how much information would you really need to verify? Not a whole lot. What is your risk? Would your rate be higher or lower in this situation? Heck, in this situation you almost hope they default on their payments, ALMOST, the point is you have very little risk.

What if they wanted to buy that $100,000 house with no money down? Hmm, you’d want to know everything you could about them, you’d charge them a little higher rate because that poses a much bigger risk to the bank.

Now, both of these loans go bad and you have to foreclose. Which one would you foreclose on first? Would you be more likely to lose money on one over the other? Isn’t there almost an incentive to foreclose on the $50,000 loan? If you foreclose on that deal you will more than likely come out just fine and recoup all your costs. If you foreclose on the $100,000 loan you are going to lose your shirt. You have months with no interest coming in, attorney costs, repairs, selling costs and you will have to discount the house to get it sold quickly. Your losses could easily hit $20,000 or more.

Do you think you would try to do what ever you could to help the $100,000 borrower get back on track in paying you back? If their situation that caused them to get behind on their payments had been resolved, but they didn’t have enough money to bring the loan current, would you consider giving them $2,000 or $3,000 in a personal loan to get them back in the game? Which of these two people would have more options with you?

Can you see where the borrower with 100% financing would have more options, especially if they had that $50,000 and just put it in a better investment than the equity in their home. They would have little risk of foreclosure if they had access to that $50,000.  They could have made payments on the house for a long time or could have had a better chance of selling their house before their money ran out.  Ultimately, they would have MORE OPTIONS!  They would have choice and control over the situation. 

In fact when banks are dealing with loans in foreclosure that are over 80% loan to value they are much more likely to enter into a Forbearance plan if the problems that caused the missed payments are cured. This is basically a revised repayment plan that allows you to keep your home. If you are below 80% loan to value the bank has no real incentive to do that type of plan. More than likely they will just foreclose and get that non-performing loan off their books because they can accomplish that with little to no loss.

Please don’t think we purposely left out that there are some additional costs to borrow more than 80% on a house. There are higher rates, not tremendously higher but higher and your payments would be higher. We just know that when you put that money that was going to go towards your down payment, extra principal reduction, or really any principal reduction is directed into a vehicle that is more liquid than home equity, safer than home equity and earns at or above our net cost to borrow (remember mortgage interest is usually deductible) then you have an excellent opportunity to come out way ahead in security for your family from life’s curve balls and that you could easily have an additional investment account with a very substantial amount in it.

If you are ready to explore how this New Rules of Money approach can benefit you and your family then just complete the information below and we'll schedule a Complimentary Mortgage Planning session with you.  Don't waste another minute let us show you how your home and your mortgage can be a powerful financial tool.

Creating Wealth Through Smart Mortgage Planning.