Author Topic: 37% of net worth in home equity; what to do?  (Read 7054 times)

RedmondStash

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37% of net worth in home equity; what to do?
« on: January 24, 2016, 06:07:09 PM »
Hi all --

Long time, first time, etc. Nice to meet you all. Spouse & I are just about bare-bones FI, though not RE; we're a bit older than most of you (50s and 60s). We're both still working, building the 'stache. No kids.

We're trying to figure out how home equity figures into our financial future. Our house is nearly paid off: After 20 years, there's $30k left on the mortgage, 5.5% interest rate, tried to refi again a few years ago but our mortgage broker said it wasn't worth it. It'll be paid off in 3.5 years. No other debt. We've been moderate Mustachians since before the term existed.

The thing is, about 37% of our entire net worth is in our home equity. After much reading here and elsewhere, I'm realizing that that money isn't working particularly hard for us. The rest of our net worth is en route to Vanguard index funds after spending a lackluster decade with a financial planner. (You live, you run performance analyses on your current assets in Excel, you learn.) We've stopped paying extra on our mortgage after realizing that although a 5.5% return isn't bad, we might do better putting those extra payments into stock & bond index funds instead of accelerating its path into yet more home equity.

My quandary is trying to figure out our best strategy for our assets. Put everything that's not tied up in home equity into stocks? Do a stocks/bonds split, even though 37% is already tied up in a relatively stable if underperforming place? Take out a HELOC (just learned about that) to get some liquidity out of our stagnant home equity and invest the $$? Buy a new house and get the biggest mortgage we can while rates are still low? That last option is unappealing because of the massive amount of work involved in moving 20 years worth of stuff into a new home while we're both working full-time, and because of the irrational appeal of owning our own home free and clear. We're more interested in optimizing happiness than in optimizing every possible penny.

We're comfortable with relatively high financial risk; neither of us blinked when we lost 30% of our net worth in 2008. We just let it ride and recover. Ideally, we'd like a 75/25 stocks/bonds split, but we're not sure how home equity figures into that.

So -- any thoughts?

Thanks.

seattlecyclone

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Re: 37% of net worth in home equity; what to do?
« Reply #1 on: January 24, 2016, 07:35:45 PM »
I ignore home equity in my asset allocation. As you say, it's not really giving you a return like your other investments. Instead, a paid-off house pays dividends in the form of rent you don't have to pay. Invest the remainder of your assets according to your preferred 75/25 split, and when that portfolio adds up to 25x your expenses, you can call it a career.

faramund

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Re: 37% of net worth in home equity; what to do?
« Reply #2 on: January 24, 2016, 10:14:41 PM »
I include home equity, but I also have the highest HELOC that I can possibly have (so home loan + HELOC = 80% of my home value, and as my home loan goes down, and my home increases in value, each year I increase my HELOC).

If you have a high risk tolerance, based on average returns, this seems the cleverest thing to do. Also, I don't know what your tax rates are, but mine is close to 50%, so I can claim half of my HELOC interest back when I do my tax (in most countries - interest on investment is a tax deduction).

steveo

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Re: 37% of net worth in home equity; what to do?
« Reply #3 on: January 25, 2016, 12:36:07 AM »
I ignore home equity in my asset allocation. As you say, it's not really giving you a return like your other investments. Instead, a paid-off house pays dividends in the form of rent you don't have to pay. Invest the remainder of your assets according to your preferred 75/25 split, and when that portfolio adds up to 25x your expenses, you can call it a career.

I do this as well. My home equity will be more than 50% of our allocated assets if we included it.

Mr. FI

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Re: 37% of net worth in home equity; what to do?
« Reply #4 on: January 25, 2016, 08:10:24 AM »

We're trying to figure out how home equity figures into our financial future. Our house is nearly paid off: After 20 years, there's $30k left on the mortgage, 5.5% interest rate, tried to refi again a few years ago but our mortgage broker said it wasn't worth it. It'll be paid off in 3.5 years. No other debt. We've been moderate Mustachians since before the term existed.

The thing is, about 37% of our entire net worth is in our home equity.

We're comfortable with relatively high financial risk; neither of us blinked when we lost 30% of our net worth in 2008. We just let it ride and recover. Ideally, we'd like a 75/25 stocks/bonds split, but we're not sure how home equity figures into that.

So -- any thoughts?

Thanks.

Honestly, the only way to leverage that equity is to sell the current house and move into something cheaper. I would wait until the home is paid off too, so you don't have to get a new mortgage.
For example, my parents' home is worth roughly $325,000 and paid off. It's way too much house for them now that the kids have moved out. So they're going to sell and move into a smaller home. They should net, after seller fees, somewhere between $80,000-90,000. And it's tax free income.

I don't know your living situation, only that you don't have kids, so maybe your current home is appropriately sized or you're not considering a move. But this is an option!
Good luck!


RedmondStash

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Re: 37% of net worth in home equity; what to do?
« Reply #5 on: January 25, 2016, 08:36:00 AM »
I include home equity, but I also have the highest HELOC that I can possibly have (so home loan + HELOC = 80% of my home value, and as my home loan goes down, and my home increases in value, each year I increase my HELOC).

If you have a high risk tolerance, based on average returns, this seems the cleverest thing to do. Also, I don't know what your tax rates are, but mine is close to 50%, so I can claim half of my HELOC interest back when I do my tax (in most countries - interest on investment is a tax deduction).

This interests me. If I understand you, you take out a loan in the HELOC and invest it, with the expectation that the return on investment is greater than the interest rate on the loan, plus you get a tax break because it's mortgage interest?

I also considered finding out current HELOC rates and if they're lower than 5.5% and also no-fee, taking out a loan and just paying off the mortgage. Instant savings/refi. :)

Thanks, everyone. I appreciate your time and advice.

RedmondStash

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Re: 37% of net worth in home equity; what to do?
« Reply #6 on: January 25, 2016, 08:40:45 AM »
Honestly, the only way to leverage that equity is to sell the current house and move into something cheaper. I would wait until the home is paid off too, so you don't have to get a new mortgage.
For example, my parents' home is worth roughly $325,000 and paid off. It's way too much house for them now that the kids have moved out. So they're going to sell and move into a smaller home. They should net, after seller fees, somewhere between $80,000-90,000. And it's tax free income.

I don't know your living situation, only that you don't have kids, so maybe your current home is appropriately sized or you're not considering a move. But this is an option!
Good luck!

Our house is a bit big for us, and we're definitely considering a downsizing move, but probably not for a year or two. We're trying to figure out where we want to live in retirement. Discussions are ongoing. :) It is food for thought. Thanks.

Stasher

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Re: 37% of net worth in home equity; what to do?
« Reply #7 on: January 25, 2016, 10:01:11 AM »
The house counts in my books
Not in the way the savings generates a cash withdrawal value in the future but in such that it allows you to not have to make that withdrawal. A 1000/month rental payment would require well over $250,000 in savings to support the 4% yearly drawings required to support the rent. You are doing fine.

onlykelsey

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Re: 37% of net worth in home equity; what to do?
« Reply #8 on: January 25, 2016, 10:09:45 AM »
Quote
(You live, you run performance analyses on your current assets in Excel, you learn.)

I'm going to make that my motto, haha.

I'd agree with Mr. FI that the way to leverage that asset is to move in to something smaller, if that's feasible for you.  If not, growing your cash elsewhere should push that 37% down without much work, no?

bacchi

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Re: 37% of net worth in home equity; what to do?
« Reply #9 on: January 25, 2016, 12:30:37 PM »
Cash out refi?

nereo

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Re: 37% of net worth in home equity; what to do?
« Reply #10 on: January 25, 2016, 12:38:05 PM »
We're trying to figure out how home equity figures into our financial future. Our house is nearly paid off: After 20 years, there's $30k left on the mortgage, 5.5% interest rate, tried to refi again a few years ago but our mortgage broker said it wasn't worth it. It'll be paid off in 3.5 years. No other debt. We've been moderate Mustachians since before the term existed.


I'm surprised to read that your mortgage broker concluded that it "wasn't worth it".  I;m guessing he was just looking at refinancing what remained on the home (~$30k) and converting that into a new mortgage with a lower payment.  If that's all s(he) did, I cna understand why the conclusion would be it's not worth it.

Did you specifically ask about refinancing while pulling out ~$100k of the equity?   IN such a scenario you might wind up with a 15yr mortgage of $130k with $100k to move into index funds.  Of course banks oftne want to know why you want the equity...

Gone Fishing

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Re: 37% of net worth in home equity; what to do?
« Reply #11 on: January 25, 2016, 12:56:47 PM »
Being on the tail end of the mortgage, your payment is probably large in relation to the balance.  Once it is paid off, how solid is your FI?  Also, are you including SS or any pensions? 

My first choice (in order of additional risk):

Honestly, the only way to leverage that equity is to sell the current house and move into something cheaper. I would wait until the home is paid off too, so you don't have to get a new mortgage.
For example, my parents' home is worth roughly $325,000 and paid off. It's way too much house for them now that the kids have moved out. So they're going to sell and move into a smaller home. They should net, after seller fees, somewhere between $80,000-90,000. And it's tax free income.

I don't know your living situation, only that you don't have kids, so maybe your current home is appropriately sized or you're not considering a move. But this is an option!
Good luck!

Our house is a bit big for us, and we're definitely considering a downsizing move, but probably not for a year or two. We're trying to figure out where we want to live in retirement. Discussions are ongoing. :) It is food for thought. Thanks.



My second:   

If you want to take on additional stock exposure, you could simply put the HELOC into place for liquidity (not to actually purchase stocks) and reduce your bond allocation a bit.

My third:

Cash out refi?

30 year fixed money is pretty darn cheap right now.  Not sure what the cash out rates look like at the moment, but they do tend to be a hair higher than purchase or a straight refi.



« Last Edit: January 25, 2016, 01:02:38 PM by So Close »

AdrianC

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Re: 37% of net worth in home equity; what to do?
« Reply #12 on: January 25, 2016, 02:02:42 PM »
I also considered finding out current HELOC rates and if they're lower than 5.5% and also no-fee, taking out a loan and just paying off the mortgage. Instant savings/refi. :)

I was going to suggest that. We did it. The risk is going from fixed rate to variable rate. We didn't intend to keep the HELOC for long (we wanted a paid off house) so that wasn't an issue for us.

Fishindude

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Re: 37% of net worth in home equity; what to do?
« Reply #13 on: January 25, 2016, 02:15:01 PM »
Nothing wrong with having your home as a substantial part of your net worth, just understand that you are going to always need a roof over your head and a place to live, so it will never put anything in your pocket until you sell, and then you will still need someplace else to live.  Depending on your particular situation, there is always the possibility of selling and moving into something more economical, then using the gain for investing and improving your situation.

I would not recommend using a HELOC to invest in the stock market.  Why put your home further in hock to invest in something that is in no way a sure money maker?
I think a better strategy would be to aggressively pay off the mortgage, then use money that would have been going towards mortgage payments to invest.

faramund

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Re: 37% of net worth in home equity; what to do?
« Reply #14 on: January 25, 2016, 02:56:31 PM »
I include home equity, but I also have the highest HELOC that I can possibly have (so home loan + HELOC = 80% of my home value, and as my home loan goes down, and my home increases in value, each year I increase my HELOC).

If you have a high risk tolerance, based on average returns, this seems the cleverest thing to do. Also, I don't know what your tax rates are, but mine is close to 50%, so I can claim half of my HELOC interest back when I do my tax (in most countries - interest on investment is a tax deduction).

This interests me. If I understand you, you take out a loan in the HELOC and invest it, with the expectation that the return on investment is greater than the interest rate on the loan, plus you get a tax break because it's mortgage interest?

I also considered finding out current HELOC rates and if they're lower than 5.5% and also no-fee, taking out a loan and just paying off the mortgage. Instant savings/refi. :)

Thanks, everyone. I appreciate your time and advice.
That's exactly what I meant.. Just note the warning, I know it works where I am (Australia), and know it works in many other countries.. but I don't know if it works where you are (although I suspect it does).

nereo

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Re: 37% of net worth in home equity; what to do?
« Reply #15 on: January 25, 2016, 03:02:02 PM »

I would not recommend using a HELOC to invest in the stock market.  Why put your home further in hock to invest in something that is in no way a sure money maker?
I think a better strategy would be to aggressively pay off the mortgage, then use money that would have been going towards mortgage payments to invest.

Because there's no guarantee that the home won't loose value.  What you are advocating is to actually increase the amount of NW tied to the home, and hoping to balance it out years down the road.  This seems to be exactly opposite of the OP's concern (that s(he) has too much NW tied up in their home currently).

Some people are ok having a large % of their NW tied to one single thing (in this case, their house).  Personally I find that to be far too risky.  Each has to make their own decision - put in a plug for everyone to fill out their own ISP here!

faramund

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Re: 37% of net worth in home equity; what to do?
« Reply #16 on: January 25, 2016, 05:02:22 PM »

I would not recommend using a HELOC to invest in the stock market.  Why put your home further in hock to invest in something that is in no way a sure money maker?
I think a better strategy would be to aggressively pay off the mortgage, then use money that would have been going towards mortgage payments to invest.

Because there's no guarantee that the home won't loose value.  What you are advocating is to actually increase the amount of NW tied to the home, and hoping to balance it out years down the road.  This seems to be exactly opposite of the OP's concern (that s(he) has too much NW tied up in their home currently).

Some people are ok having a large % of their NW tied to one single thing (in this case, their house).  Personally I find that to be far too risky.  Each has to make their own decision - put in a plug for everyone to fill out their own ISP here!

Also, I'm very lucky down here in Australia, my HELOC interest rate is just under 5%, my tax rate is 39% (call it 40). So my interest rate is really 5*(1-0.4)=3%, and my shares give a dividend of 5%. So my dividends pay the HELOC interest, and would still do so if my dividends dropped by 40%. Back in 2008 dividends dropped by 20%, but they recovered that in the next 2-3years. So I actually think, I'm not taking on much risk at all.

MustacheAndaHalf

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Re: 37% of net worth in home equity; what to do?
« Reply #17 on: January 25, 2016, 05:27:02 PM »
Your total bond fund earns 2.25% while the mortgage costs 5%.  Assuming (I don't know) a tax bracket of 25%, the mortgage still costs 3.75% after the tax deduction.  The 2.25% vs 3.75% gap means that $30k of the bond fund gets canceled by your mortgage, and then you pay another $450 this year (declining as you pay down the mortgage).

Not sure cashing in equity for investment, as others suggested, makes sense for someone comfortable with 75% stocks/25% bonds.  If OP wants more stock exposure, they can raise their stocks to 100% rather than go into debt.

RedmondStash

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Re: 37% of net worth in home equity; what to do?
« Reply #18 on: January 25, 2016, 05:56:43 PM »
First, you've all been so helpful, thank you.

Cash out refi?

I'd never even heard of such a thing; this is intriguing! I grew up believing that all debt is bad debt, so the idea of taking on debt to leverage into investments as a gamble that they'll pay off is new to me. But the math bears out in the long term. Must think about this.

Did you specifically ask about refinancing while pulling out ~$100k of the equity?

Nope, because I didn't know it was possible. Now we have more options, which is great.

Being on the tail end of the mortgage, your payment is probably large in relation to the balance.  Once it is paid off, how solid is your FI?  Also, are you including SS or any pensions? 

Once the mortgage is paid off, our FI is pretty solid, especially since we plan to keep working at least for the rest of this year and fattening the 'stache. We are including spouse's SS, though we won't take it for another year and a half.

Basically it boils down to: take on more debt and more risk with potentially higher rewards, or reduce debt and risk, but also reduce the potential rewards. (Though if we can get a HELOC at lower than 5.5% and pay off the current mortgage with it, that seems like a good bet, provided a reasonable expectation that HELOC rates will stay under 5.5%.)

Thanks again, everyone. You've given us a lot to think about. Much appreciated.

RedmondStash

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Re: 37% of net worth in home equity; what to do?
« Reply #19 on: January 25, 2016, 06:25:17 PM »
Quote
(You live, you run performance analyses on your current assets in Excel, you learn.)

I'm going to make that my motto, haha.

:)

I'd agree with Mr. FI that the way to leverage that asset is to move in to something smaller, if that's feasible for you.  If not, growing your cash elsewhere should push that 37% down without much work, no?

That's a good point. I do kinda want to grow the cash faster by having more of it in actual investments, but either way, it will happen on its own over time.

onlykelsey

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Re: 37% of net worth in home equity; what to do?
« Reply #20 on: January 25, 2016, 07:02:41 PM »
Quote
That's a good point. I do kinda want to grow the cash faster by having more of it in actual investments, but either way, it will happen on its own over time.

Of course I have 81% of my NW in my house since I bought two years ago in Manhattan, so I may not be the best person to ask.