Disclaimer: As you read through this information we would like to give credit where credit is due. This information is what we feel are the condensed highlights from a book called Missed Fortune written by Douglas Andrew. It is a great read, but as a consumer we recommend reading his Lite version- Missed Fortune 101.

Myth #1

The best way to pay off a home early is to pay extra principal on your mortgage.

Reality:

No method of applying extra principal payments to your mortgage is the wisest or most cost effective way of paying off your house.

If you believe the following to be TRUE:

Your home equity is a prudent investment
Extra principal payments on your mortgage saves you money
Mortgage interest should be eliminated as soon as possible
Substantial equity in your home enhances your net worth
Home equity has a rate of return

Don’t fall for the bi-weekly program or the 15 Year mortgage.

You can accumulate sufficient cash in a conservative, tax-advantaged mortgage acceleration plan to pay off your home just as soon or sooner- sometimes in less than half the time than with traditionally accepted methods. Additionally you will have the following advantages:

Maintain flexibility, liquidity, and safety of principal by allowing home equity to grow in a separate side fund where it is accessible in case of emergency, temporary disability, or unemployment.
Maximize the only real tax-deductible interest allowed non-business owners by keeping the loan balance as high as possible until you have the cash accumulated to pay off your home in a lump sum. In a typical tax bracket you can actually pay off a $150,000, Thirty Year mortgage in 13.5 Years using the same cash outlay required by a 15 Year mortgage. This is partly due to the use of $12,000 to $20,000 (depending on your tax bracket) of Uncle Sam’s money instead of your own money.
Maintain control and portability of your home equity to allow an increase in its rate of return. Most homeowners relocate an average of every seven years. Your home will likely sell much easier and for a higher price with a higher mortgage balance than with a low mortgage balance. Regardless of real estate market conditions, your equity should always be kept highly liquid.

Home equity is most people’s greatest asset and it is commonly misunderstood and mismanaged. It is such a shame that we spend so much time and energy learning how to make money, but we spend almost no time and energy learning what to do with it after we earn it.

It is our contention is that a home is “paid for” if you have significant enough liquid assets in a safe environment that could wash out the liability of my mortgage. Our client’s sleep better at night with their home fully mortgaged, when the equity is removed from their property and repositioned in a safer, more liquid environment.

Contrary to popular belief, any conceivable financial setback can likely be best resolved if your home equity is separated from your property rather than trapped in it.

Think about it this way, every time you pay an extra principal payment to the mortgage banker, you are in essence saying. “Here, Mr. Banker, is some extra money. Don’t pay me any interest on that money! If I want it back, I will borrow it back on your terms and prove there’s a valid reason why I should have it!” How ridiculous! Yet, every time we pay extra principal payments, this is exactly what we are doing.

Myth #2

Home equity is liquid.

Reality:

When you need it most, you may not have it. Home equity is usually not liquid.

If your Investment Consultant offered a particular investment for your consideration, you would likely ask the following questions.

How liquid would my money be? In other words, you would want to know how easily you could access your money at given time if you need it. Liquidity is probably the number one consideration for any prudent investment.
Would my money be safe? Is the investment guaranteed and/or insured? What element of safety is inherent in the investment?
What rate of return can I expect? Most people are usually willing to five up a little safety to get a little return. Even depositing money in a bank requires that we give up some safety to obtain some rate of return. We all want maximum and minimum risk.
What about the tax consequences? A tax-favored investment will, in the long run, achieve a higher net rate of return by virtue of its tax benefits.

Let’s address the liquidity question. How important is it to have the liquidity necessary to get you through the tough times? How will you cope when unexpected circumstances arise from external forces over which you have no control?

Suppose you had been doing what many homeowners do—that is, making extra principal payments on your mortgage every opportunity you had. Over a period of five or six years you would have paid a substantial amount against the principal of your mortgage with those extra payments. What if all of a sudden you found yourself with a physical disability or unemployed? You would go to your mortgage banker and explain. “Mr. Mortgage Banker, I was faithful all these years; in fact, I even paid you extra money. Will you please let me coast now for a little while since I am way ahead of schedule?

You will be told you have to fill out a loan application to see if you qualify.

A man who owed $100,000 on his home and he received a $90,000 windfall and paid it all down on his mortgage. With only a $10,000 balance remaining (The payments were still based on $100,000), he became disabled and lost his income. Still his normal mortgage payment was due the next month He missed three consecutive payments. He wasn’t able to borrow back any of the $90,000 he had just paid because he lacked the ability to repay. His home was foreclosed on. (He could have sold his home, yet his foolish pride didn’t let him sell before he lost his home.)

Physical disability is a major cause of foreclosure in America. What’s more, the chances of becoming temporarily financially disabled at some point in life are far greater than becoming physically disabled.

The most important reason to keep equity separated from property… Liquidity

Who controls the ability to get cash out of your property? Is it you, the owner? No, it’s the bank!

Position yourself to act instead of to react to market conditions over which you have no control. Separate as much equity from your property as is feasible, positioning it in financial instruments that will maintain liquidity in the event of emergencies and conservative investment opportunities.

Myth #3

Home equity is a safe investment.

Reality:

Remember question #2 you should have for any investment? Would my money be safe? Is the investment guaranteed and/or insured? What element of safety is inherent in the investment?

It is our contention that a home mortgaged to the hilt or totally free and clear provides the greatest safety for the homeowner. Whether you have mortgaged your home to the hilt or own the home free and clear, you still have the same amount of equity, but the liquidity and safety of your equity can be greater if you keep it separate from the property.

Our recommendation is that people have their home mortgaged as high as is feasible for their budgets. Some want to own their homes totally free and clear because it gives them peace of mind. That desire is understandable. However, the road to that peace of mind may come at an extremely high price. For equity to be in as safe as position as possible, we contend it must either be repositioned out of a home by mortgaging it to the maximum amount feasible, or left in a home that is totally free and clear. Any place in between is a risky position from a safety and liquidity standpoint.

The more equity you accumulate and leave trapped in the home, the less safety your equity investment has, if real estate markets take a sudden turn downward, your equity suffers, and the safety of your investment has been compromised. Where as if your equity has been repositioned into a safe investment you still have that money so you have many options on how you handle that drop in your home’s value.

Rest assured, having safety of principal versus money tied up in your property, opens up crucial alternatives for financial recovery.

The second most important reason to keep equity separated from property… Safety

Real estate equity is no safer than any other investment whose value is determined by an external market over which we personally have no control. In fact, due to the hidden “risks of life”, real estate equity is not nearly as safe as many other conservative investments and assets.

Separate as much equity from your home as is feasible to achieve greater safety of principal.

Myth #4

Homes with a lot of equity are less likely to be foreclosed upon.

Reality:

Homes with substantial equity are usually the first ones mortgage bankers foreclose on if their mortgages become delinquent.

It’s important to understand the value of a home is not contingent upon how much the mortgage is.

A major cause of foreclosure in America is physical disability. The chance of becoming financially disabled is even greater than physical disability, which highlights the importance of having liquid assets. A liquid side fund allows a homeowner the flexibility of using extra dollars for savings and investment opportunities, and the ability to keep the mortgage current if the need arises.

Liquidity also allows a degree of flexibility that not only will keep your credit rating healthy, but will also give your equity far more protection than putting it in the hands of the mortgage banker. To reduce the risk of foreclosures during unforeseen setbacks, keep your mortgage balance as high as feasible. Keep your equity separated into a position of liquidity and safety until you are ready to pay off the entire mortgage in a lump sum.

Think about it this way, if you were a banker and had two houses that were going into foreclosure both worth $200,000, owner A has a $100,000 mortgage and owner B has a $200,000 mortgage. Which house would you foreclose on first? Owner A’s home has the potential for the bank to actually avoid a loss from foreclosure where Owner B’s home is a sure loss. In fact the bank is more likely to work with Owner B in getting things back on track. (Of course if you follow a plan you would have had the money available to prevent foreclosure).

Myth #5

Home equity has a rate of return.

Reality:

Remember question #3 you should ask about any investment? What rate of return can I expect? Most people are usually willing to give up a little safety to get a little return. Even depositing money in a bank requires that we give up some safety to obtain some rate of return. We all want maximum return and minimum risk.

What Rate of Return does home equity give us?

Equity grows as a function of real estate appreciation and mortgage reduction however equity has no rate of return.

Assume $100,000 house that appreciates at 5% a year- after a year the house is worth $105,000. The value would be the same whether you owned the home free and clear with no mortgage or had a $100,000 mortgage on the property. Since appreciation is not affected by how much you owe on the home the home equity has no Rate of Return. The property will be worth what it is going to be worth no matter how you have it financed.

If you had no mortgage on your home you earned $5,000 from the appreciation you would have made $5,000. If you had a $100,000 mortgage (and invested that $100,000 in an investment earning 10% it would be worth $110,000 in a year) so you earned the $10,000 on the investment and the $5,000 in appreciation or $15,000 which is three times the amount if you earned from the just the appreciation.

Every time we put extra or excess cash into our properties, we give up the ability to earn a rate of return on that money.

The third most important reason to keep equity separated from property… Rate of Return

Home equity passes neither the liquidity, nor the safety test, nor the rate of return test—that’s three strikes.

Separate as much equity from your home as feasible in order to allow idle dollars to earn a rate of return.

Myth #6

Mortgage interest is an expense that should be eliminated as soon as possible.

Reality:

Eliminating mortgage interest expense through traditional methods eliminates one of your best partners in accumulating wealth and financial security.

There are three kinds of people in the world:

Those who pay interest,
Those who earn interest,
Those who pay interest in order to earn greater interest—just like the highly profitable banks and credit unions.

Have you ever wished you could make money like a bank? Well our contention is you can. See, debt can be a wise and prudent money-management tool. Banks borrow from the Federal Reserve at say 4.5% and then turn around and lend it at 8% they can make a handsome profit, especially on large sums. Why can’t you do the same?

What is keeping you from borrowing money on your home at say 6% and since there are some tax advantages on the interest your effective rate in a 34% tax bracket (27% Federal, 7% State) would be 3.96%. We refer to mortgage interest as preferred interest. So if you can borrow at an after tax rate of 3.96% and earn say 6.25% in a tax advantaged investment, wouldn’t you want to borrow as much as you could comfortably afford?

This is done everyday, especially by the wealthy. How do you think they created their wealth and make sure it continues to grow?

Myth #7

Any and all debt is undesirable.

Reality:

Some debt, when managed wisely, can be desirable.

In equity management, owning a home free and clear and carrying no debt may appear to be a positive. But, really, it is a negative. When viewed in terms of liquidity, safety, and rate of return, these factors could very well surprise you when an you have an unpleasant experience.

Perceived negatives of debt:

Home mortgage debt usually consumes up to 29% of your gross income, the amount of interest can be double or triple the eventual cost of their homes.

Another perceived negative in sound financial budgeting is insurance, sometimes referred to as a “necessary evil’ for risk management. Insurance is a form of risk management that is best purchased before the emergency arises and you actually need it. Just like insurance, it is much better for you to obtain the key to accessing one of your most important assets—equity in the home—before an emergency arises and is actually needed. Like in arithmetic multiplying the negative of a mortgage and the negative of insurance creates a huge positive—the tremendous enhancement of our net worth.

We believe in conserving home equity by repositioning it into safe, liquid investments earning a rate of return at or above the net cost of my mortgage interest. The investment vehicle we have used for a liquid side fund allows you to peel off dollars to invest when opportunities arise.

Three main points:

Use debt wisely as a positive lever in equity management, conserving your equity, and enabling you to seize opportunities to use that equity to enhance your net worth.
Always protect yourself; ensure that in the event of unforeseen delays and costs, you may be able to recover adequately by maintaining flexibility, liquidity and contingency options.
Don’t take unnecessary risks. Conservative, safe returns of only 5 to 9 percent can make you thousands.

Use debt wisely as a positive lever for equity management purposes, conserving and compounding equity rather than consuming it.

Myth #8

Lower mortgages, resulting in lower payments mean lower costs.

Reality:

If you take opportunity cost into consideration, low mortgage-to-home value ratios create tremendous hidden costs that increase the time needed to pay off a mortgage. If you believe lower mortgages-thus lower payments- means lower costs, maybe you have never been taught the cost of a lost opportunity. There are 2 ways to separate equity from property into a cash position. First- sell the property, this is not an option if you want to stay in the home. The second way is through a mortgage.

Let’s explain opportunity cost. As an employer why would one be willing to hire an assistant for say $30,000 per year? It’s because by hiring an assistant you can have them do things that allow you to go out and make much more money than $30,000 (otherwise why would you hire someone). This is what we call employment cost. So if you could make an additional $60,000 in a year by hiring a $30,000 employee, would you hire that employee? It costs you $30,000 to make an additional $30,000- that’s a no brainer.

In like manner whenever equity is separated from a property, you are going to incur an employment cost (interest expense on the mortgage). Why would you be willing to incur an employment/ interest cost on your equity? Because you know you can get a return equal to or greater than the cost of the equity that you employ. Perhaps surprisingly, if you choose to leave $100,000 equity in your home, you incur almost the same cost. The only difference is, instead of referring to that cost as employment cost, it is referred to as opportunity cost.

Leaving the equity in the property you give up the opportunity to employ it in some type of investment that would earn say an 8% return. If you choose to separate the equity and invest it in an instrument that would earn 8% you pay an employment cost. Either way it costs you. Your true employment/interest cost may not be the rate on your mortgage when you factor in the tax advantages allowed with home mortgage interest. The true cost of an 8% (APR) mortgage in the 34% marginal tax bracket (27% fed and 7% state) so on $100,000 mortgage you pay $8,000 in interest but 34% of that is in tax savings or $2,730 so their true cost of borrowing is only $5,280 so a 8% rate after taxes is only 5.28% (We are not tax advisors always consult a tax advisor.)

If an 8% employment cost is tax deductible, but the lost opportunity cost to invest those funds is a non-deductible 8% are they really equal? You may be thinking if you employ your equity in an 8% yielding investment, you’ll have to pay tax on that interest and you only net 5.28%. Not when you put that investment into a tax advantaged investment vehicle.

First, you can still enhance your net worth because the employed equity is compounding whereas the cost of the mortgage interest is computed on a simple interest tax deductible declining balance basis. Because of compounding interest to make a profit over the long run, it is not even necessary to earn an interest rate equal to or greater than the net interest rate cost of borrowing those funds. That is because, sooner or later, you will be earning interest on a much greater sum of money than you are paying interest on. If we put that investment into a tax preferred vehicle- the interest on the mortgage is tax deductible so the compounding interest on a tax favored investment vehicle the potential for growth is even greater.

The effects of tax preferred borrowing and investing. We are not giving up the opportunity to experience appreciation if we separate our equity through the use of a mortgage. We are simply taking dormant, lazy dollars from the home and providing an opportunity for those dollars to earn a rate of return. Remember, equity has no rate of return when trapped in the property.

Home Made Money-

Taking idle equity and turning it into a substantial profit at conservative rates of return is truly the key to substantially enhancing net worth. Two Key Elements to Turbo Charge your Wealth Growth Rate

Borrow funds at the most attractive rate possible. An interest only home mortgage is by far the most desirable vehicle because you can maximize the deductibility of the interest, fully using Uncle Sam as your partner. Amortized loans also work well, but they slowly trap your equity in the home again, possibly requiring more frequent refinancing.
Invest in a safe environment yet earn the highest rate of interest possible. Invest in a tax-favored or even tax free low-risk vehicle. Moderate returns in a safe environment will yield excellent results. It’s not worth risks on serious money like home equity to try to earn higher returns. This is not a get rich quick scheme, let common sense and compound interest create your wealth safely and slowly.

By applying the fundamental principle that highly profitable financial institutions use to accumulate and create wealth- arbitrage. We can employ equity to earn a rate of return higher than the net cost of separating that equity. By doing so, you will create tremendous wealth and substantially enhance your net worth.

Myth #9

Equity in your home enhances your net worth.

Reality:

Equity in your home does not enhance your net worth at all. Separated from your home, however, it has the ability to dramatically enhance your net worth over time.

Assume a $200k home and 5% appreciation per year. Doesn’t sound that great but if you only used 20% of the 200k to control that asset then the return looks a lot better. That means putting 20% down ($40,000) on the house. Five percent appreciation on a $200,000 home is $10,000 and if you only had $40,000 of your money into the house that’s a $10,000 return on $40,000 or a 25% return.

By borrowing to conserve rather than to consume your equity, and by keeping the money liquid, you are protecting yourself against a down market when it may be critical to meet the liabilities created by separating the equity.

By refinancing as often as feasible and properly managing the excess equity accruing within the home during that time, you as a homeowner could achieve the enviable position of having substantial assets that far exceed your liabilities.

You should consider refinancing your home every time the interest rate is even slightly better than your current rate or your current mortgage balance is 80% or less than the fair market value of your home. It is usually advantageous to refinance your home as often as every two to five years, and every time you do so you shorten the time table to pay off my home- not the term of my mortgage.

Give yourself the ability to accumulate enough funds to pay off the new higher mortgage sooner than you would have been able to pay off the former lower mortgage. This can be true even if you have to borrow at a higher rate of interest than my previous mortgage rate.

Continually refinancing your home or purchasing new homes in order to take advantage of accumulated equity allows you to substantially increase your net worth on that asset by as much as double every 5 to 10 years. This was possible after reaching the crossover point- the point where you have enough liquid funds needed to pay off the property.

Myth #10

The amount of equity you have in your home has no bearing on how marketable it is.

Reality:

Your home may likely sell much more quickly and for a higher price if it has a high mortgage balance rather than a low mortgage balance especially in soft real estate markets.

Assuming you have been following the idea of keeping the equity in your home separated you would have that money available in a liquid account that you could tap if you needed to. That means you have more options in selling your home.

If the real estate market is soft you may not get enough to pay off your mortgage and the real estate commission, but since you had separated the equity in your home when you had it, you now have the ability to use some of that cash to buy your way out of the home, plus you were able to earn the interest on that money for the time that you had it invested.

Let’s say you bought a home for $200,000 four years ago and we financed the full $200,000 even though you had $50,000 to put down. You invested that $50,000 and it earned an average of 6% per year so you now have $63,123.85 in that account. You had hoped that the 5% of appreciation on your $200,000 home would continue to make your home worth $243,000 after the 4 years, but it is only worth $205,000. After the selling costs your net is $190,650 and you owe $200,000 so you need to come up with $9,350 to complete the transaction which brings you separate account from $63,123.85 - $9,350 = $53,773.85.

Where, if you would have financed it traditionally, your net is $190,650 minus your estimated payoff on your mortgage which is $144,000 or $46,650 which is $7,123.85 less than the scenario above. So, you would have been $7,123.85 ahead by separating the equity. Not too bad for 4 years in a “down market”.

Myth #11

Financial security is, to a large degree, achieved when your home is paid for.

Reality:

It can be argued that financial security is usually obtained with adequate liquid assets in a safe environment to cover any liabilities and generate positive cash flow to cover living expenses indefinitely.

One of the biggest obstacles we have to overcome with people is their perceptions about financial security and how they need to get their homes paid off as quickly as possible. It’s certainly understandable where this thinking comes from. Our parents and grandparents have taught us to get your house paid off so the bank can’t take your house and you don’t have to pay that bad old interest.

Now our parents and grandparents are well meaning in their advice, but their advice is set from the “Depression Era” where even if you were making your house payments on time, if the Bank needed money they could call your note due and payable and if you couldn’t pay it off they would take your house. That was true during the Depression but those lending laws have changed. There is no longer a call option in the note. The only time a lender can do that now is if you Default on your loan- quit making payments on time.

Also, there are some telling statistics about how our parents and grandparents have managed their money. Only 5% of the population retires with enough money to live the lifestyle they lived when they were working for the rest of their life and only about 3% of the population has saved enough money to pay cash for their kid(s) college education. So basically, we are modeling our investment behavior after a model that has failed miserably. How smart is that?

It is our contention that separating equity in one’s home into a safe, conservative, tax advantaged, and liquid investment that earns the same or more than the effective interest rate they are paying on their mortgage is the quickest, safest and most effective way to achieve financial security.

Myth #12

You will be in a lower tax bracket when you retire than when you were working.

Reality:

With the 1996 Tax Reform Act and subsequent reform, most retirees in America will find themselves in a tax bracket at least as high if not higher than during their earning years. Why? Fewer deductions and exemptions.

Shocking Statistic:

Most retirees pay back every dollar to Uncle Sam they saved in taxes during the contributions phase of their qualified retirement account(s) during the first 18 to 36 months of their actual retirement. Those accounts that allow you to fund them with before tax dollars and they grow tax deferred, but are withdrawn in a taxable environment.

In fact, the average retired couple will pay 8 to 12 times more in taxes on their IRA’s and 401(k)’s during their retirement years than they saved during their contribution and accumulation years. Thanks to “Traditional Thinking” retirees lose almost all of their tax deductions, mortgage interest and dependents. So even though their cash flow may be lower, without these deductions their taxes are many times actually higher. Qualified retirement plans may be one of the best savings bonds the government has ever instituted as a way to generate future tax revenue.

Since money that is grown inside qualified plans is not only subject to income tax as it is withdrawn, but also, in the transfer phase to an estate, taxes may be due upon the second death of two spouses deaths as the remaining money passes down to non-spousal heirs. Therefore retirement plan assets may be essentially taxed twice.

It is usually advisable to get qualified money out, taxed and repositioned in a tax-free environment rather than leave it there to continue to compound the problem. Delaying the withdrawal at 59 ½ could cost you a fortune if you wait. Even if you are over 59 ½ it may not be too late to move funds over to a much better vehicle to house your retirement nest egg.

Creating Wealth Through Smart Mortgage Planning