Strategic Equity Management
That is the name given to a new school of thought which runs contrary to previous generations plans of paying off their home for “Peace of Mind” in retirement.
Many residents of New Orleans and many homeowners in Southern California can now attest, having too much equity in your home can be disastrous in certain situations. Natural disasters can wipe out the best laid plans. Yes, insurance may cover a major portion of the loss but how do you live while the rebuilding takes place? Needless to say in the face of a natural or human based disaster, would it not be best to have the liquidity to have many survival options for your family?
Also consider the retired who scrimped and saved, paid off their mortgage yet now struggle to make ends meet. Many times their only option is to take a Reverse Mortgage which is limited by several factors and has very high initial closing costs (typically in the area of $18,000 to $20,000). I am not disparaging the Reverse Mortgage as this is the only lifeline that many seniors need to live out their lives independently and with dignity. But the necessity of the Reverse Mortgage begs the question: what is the best wealth creation plan?
There is another strategy to contemplate as an alternative to paying off your home. While in your prime earning years instead of paying extra towards the principal on your mortgage, consider refinancing to take out equity and using those funds for alternative investments. This is also simply known as diversification of assets and is a strategy recommended by many financial planners. There are also tax benefits to consider as the mortgage deduction effectively would reduce the effective interest rate on a 6% mortgage to approximately 4.5%.
I recently met with a young professional whose annual earnings exceed $150,000. He has always had a very conservative approach and owns his home which is worth over $425,000. He has a $100,000 15 year fixed rate 4.5% mortgage and over $300,000 equity. His mortgage deduction is less than $4,500 a year providing little tax benefit for his salary bracket. In this real estate market the likelihood of having any appreciation on this investment over the next 3-5 years in next to nothing and as a matter of fact may even lose some value. Why not free up some of that equity to invest and diversify? It will only enhance his true long term goals of wealth accumulation, provide better liquidity and the diversification required of any well balanced investment portfolio. Yes….your home is really a major part of your investment portfolio and in the case of many, their primary investment.
An old saying is that only a fool represents himself in court. This may apply to other areas of our life as well. While some are excellent money managers and planners, many are not. They tend to follow their grandparent’s financial path, which in most cases, may no longer be relevant. A sound “holistic financial plan” should involve professional assistance beginning with a trust attorney and perhaps a financial planner. A trust can be completed for as little as $500 or up to $3,000, but don’t skimp. This is not an area to compromise. A trust is like the constitution, always changing as our life events change. and needs to be done by professional legal council to protect your family and your assets.
Beware of having your nest eggs all in one basket.
Keith Webb
CEO