Author Topic: How the Affluent Manage Home Equity to Safely and Conservatively Build Wealth  (Read 4067 times)

GuinnessPhish

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My wife is getting her MBA and this article is part of her current course:

http://www.clevelandhousingmarket.com/images/MortgagesAreNotBad.pdf


Just wondering if anyone had any comments or criticisms about it.

Thanks!


joonifloofeefloo

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I only skimmed it, and am posting here to bookmark it for future, but what I saw in my quick glance was fabulous! Seems to jive with what the folks on a thread here assert, too. I still don't do it only because I'm in Canada and generally can't lock in for the full term of the mortgage, and don't want to get dinged by rate hikes. But if I were in the US? Yep.

Alim Nassor

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Makes a lot of sense.   I'm curious about others reactions.

secondcor521

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I read parts and skimmed parts.  Overall, I find the authors to be condescending and cheezy, but I've been a little cranky lately.

Some of what they say is accurate, some seems to be pulled out of thin air with no data/citations/evidence/logic, and some seems dangerously wrongheaded.

Basically, it is generally true that you can probably build wealth by getting a big fixed-rate mortgage on your home and investing over the long haul in something with a higher average rate of return.  There are tax implications and risks associated with this that they seems to gloss over.  The recommended investments on the last page generally have high investment fees and costs associated with them that they also glossed over as far as I could see skimming that part.

Nords carries a mortgage and invests with the proceeds; I don't.  We're both retired and I think generally understand each other's reasoning and both approaches can work.

srad

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Also has a lot to do with how much money you need in life.  Both my parents and in-laws are receiving very nice pensions and social security.  They are set for life barring the collapse of the economic world.  So I wouldn't recommend they risk any new fixed costs.  But as for my wife and I,  there are no pension plans for us, its up to us to create revenue streams for our retirement.  My choice of cash flow will be rentals. In order to procure more properties I need cash and where am I going to get cash?  From long 30 year fixed interest rate mortgages.  Here is a real life example for you. 

One of my oldest rentals (owned since 2002) has appreciated very nicely, and was only making me a few hundred a month.  I refinanced it back in 2011 to a 15 year mortgage so I had 10 years remaining.   In 10 years i'd be clearing around 2k a month.  I thought I had a great plan, but then I learned about leverage and the benefit of having a long 30 year fixed rate mortgage.  I pulled out 180k from that property and used that money to buy more rentals.  Now that original rental is still making me the same few hundred dollars a month, but my new rentals are netting me 2500 a month.  All this cost me zero out of pocket.  In fact pulling out that 180k gave every cent I put into that original rental back to me plus a ton more. I now have an asset paying me a couple hundred a month that I have no money invested in, that's an infinite return on investment.  Another thing to note, that 180k I pulled out was tax free.  And the kicker,,,  I'm not paying any of these mortgages, my tenants are. 

One more point the article did not mention is the benefit of inflation.   I don't think anyone here will say a $1000 today will have the exact same buying power as $1000 in 20 - 30 years.  Your 1k mortgage payment now will seem like peanuts in 20 years. This alone is enough to make the argument for keeping a long 30 year mortgage.

secondcor521

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Leveraging up for wealth building works but it comes with risk.  If one considers the risk and still decides it is worth it given a person's situation, goals, priorities, etc., then I think that is all well and good.

If one ignores the risk or minimizes it without good reason or if a person takes on more risk than they have capacity for, and the risk goes against a person, then that can cause problems and result in an overall loss of wealth.

I'm not saying this applies to the previous poster in particular, but taking his
  • situation as an example:  Sure, taking equity out of a rental to invest in more rentals works as long as it works.  If a recession hits and his tenants move elsewhere, he is still on the hook for multiple large mortgages.  He will either be forced to feed out of pocket (a large cash outflow) or sell, possibly/probably at a capital loss (another large loss of wealth).


Again, it works until it doesn't.  I haven't been bit personally by anything like this, but I saw people get bit by investing in QQQ in 2000, and by MBS investments in the 2008 time frame.  Whenever I see an investment or opportunity that is represented as a brain-dead can't-miss certainty, I wonder why it exists if it's such a good deal.  It should have been arbitraged out of the system already.  I do think these kinds of opportunities exist - when I see $20 bills on the sidewalk I do pick them up - but I also think that sometimes the risk is glossed over.

My key point is that investors should consider risk, not gloss over it.

  • Don't know and didn't look whether previous poster is male or female.  Excuse my laziness and apologies if previous poster is female.

srad

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This was a post regarding the benefits of taking out a 30 year mortgage.  I was only giving an example as to when and how it can make sense.  Yes, I glossed over a LOT in my examples.  Leveraging up and becoming a landlord is not something you should go out and do just from reading one guys post (yep I'm a guy :).  There are tons of risk to this, as you pointed out, and I do my best to mitigate them from the beginning.  Education is very important here, you really need to understand the area you are buying in, types of properties available, types of renters who will rent them, local economy, housing supply, market rents etc...  Oh another big one is make sure the property is cash flowing from day 1, you do not buy a property that you have to feed each month in hopes it appreciates 20% a year.  That took out many in the 2008-2010 fall of the market.

And I guess in full disclosure, I do have one rental still on a 15 year mortgage, I have about 10 years to go and I don't plan on leveraging up that one.  Many leveraged properties or a few paid in full? that's a whole other debate.  But I do want a few paid in full properties before its time for me to retire.  Just in case.

cheers

ChrisLansing

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I think it has to do with class perspective.   If you anticipate trouble with employment, and have a modest income, then the security of owning the house is attractive.    The title says it - how the affluent manage equity - that's not how people who can barely qualify for a mortgage manage equity.     IOWs, Grandpa's advice was based on being working class, just able to make the mortgage, and having nothing in excess to invest.   Paying off the mortgage "early" probably ment a few years early, not cutting the life of the mortgage in half.     

« Last Edit: June 30, 2017, 07:54:29 AM by ChrisLansing »

BlueHouse

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My wife is getting her MBA and this article is part of her current course:

http://www.clevelandhousingmarket.com/images/MortgagesAreNotBad.pdf


Just wondering if anyone had any comments or criticisms about it.

Thanks!
Yeah, I have a criticism!  How the fuck is it possible that authors of an article included in Graduate-level coursework don't know the difference between principle and principal?  And why didn't the professor refuse to use it when it hadn't been edited? 

I'm tired of our learning institutions being dumbed-down and allowing crap product to get to students.

END Rant.  (sorry)



Another Reader

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I'm surprised this sort of article, which is obviously dated and also poorly written, is used in an MBA class.  Says something about what is taught in that program.

monarda

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I really don't know what this professor is intending, but it actually works really well for a teacher to assign a set of articles with opposing viewpoints to get the students really thinking and participating in class situation.
This sort of article can really spark a nice discussion. OP, I'd be interested to hear from your wife regarding what the actual discussion about this article was like in the classroom.

 I teach plant biology. When the topic of GMOs comes up, let me tell you...there's a lot of crap out there that works quite well to illustrate misconceptions that spin off of legitimate ideas and concerns.
It's really important to be able to recognize bad articles as well.

And yeah, BlueHouse, poor spelling and grammar bugs me, too. Instantly lowers my opinion of whatever article (or forum posts, for that matter- though the Grammar Nazi thread is a tad OTT )

BlueHouse

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I teach plant biology. When the topic of GMOs comes up, let me tell you...there's a lot of crap out there that works quite well to illustrate misconceptions that spin off of legitimate ideas and concerns.
It's really important to be able to recognize bad articles as well.

And yeah, BlueHouse, poor spelling and grammar bugs me, too. Instantly lowers my opinion of whatever article (or forum posts, for that matter- though the Grammar Nazi thread is a tad OTT )
@Monarda,
This eBay listing is relevant for you today!  It's a giant GMO Corn-Fish sculpture AND, for the mustachians, it even comes with a FREE CAR!

http://www.ebay.com/itm/034-World-039-s-Best-Hood-Ornament-034-Fishy-Corn-outdoor-road-worthy-sculpture-on-car-/332285152847?ssPageName=ADME:L:LCA:US:1123

sol

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As an MBA teaching tool, it's fine.  Students are supposed to read all kinds of crap, so they can learn how to tear it apart.

But as good advice, that article falls far short.  I'm not even an MBA and I can see a handful of obvious problems.

1.  Please tell me where I can find this "risk free, conservative" tax free 8% investment they keep suggesting as an alternative place to put your money.  It doesn't take a genius to see that a guaranteed 8% return is better than avoiding a 5% interest rate.

2.  Their tax treatment is bogus.  You don't actually get the full benefit of the mortgage interest tax deduction.  Hardly anyone does, because you would have taken the standard deduction anyway.  Mortgage tax deduction only has any value to you if you itemize, and can deduct more than the standard deduction, and then it is only worth the amount by which your deduction exceeds the standard deduction.  For poorer people with smaller mortgages, this is probably zero.

3.  The emphasis on liquidity is presented in a vacuum, as if your only options are mortgage debt plus savings or equity plus cashflow problems.  What if you bought a reasonable house and could float the payments regardless of equity paydown?  What if you have a million dollars in your taxable account and are using the mortgage debt like an appreciable bond, in which case you WANT a low fixed rate?  What if you live in San Francisco, where the average time on market is 11 days?  What if you have a Heloc? Liquidity is a significantly more complicated topic than they have grappled with here.

4.  Did they totally ignore capital appreciation/loss?  Houses that cost 85k and houses that cost 850k do not experience identical price swings or carrying costs.  In my area, the rate at which your mortgage gets paid down or invested is inconsequential compared to 40% leveraged appreciation every year.

5.  The overall message here seems to be "rich people get richer because they take more risks."  No shit, Sherlock.  Rich people never worry about having enough to eat, or a paying a surprise dental or car repair bill.  They get to play with their play money while working stiffs try to make ends meet.  Anyone can get rich with leverage when times are good, but only the rich can afford to risk the times being not so good.  The rest of the world needs a more conservative fall back plan to avoid total wipeout, and that prevents them from benefiting from high risk high reward strategies like this.

Nords

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My wife is getting her MBA and this article is part of her current course:

http://www.clevelandhousingmarket.com/images/MortgagesAreNotBad.pdf


Just wondering if anyone had any comments or criticisms about it.
If this is "curriculum" then that MBA might not be worth the money they're charging for it.

Although some Americans become rich from mortgage leverage, the vast majority have become rich from owning their businesses or from high savings rates (or both).  A rich person might keep a mortgage because they have enough money to afford one, not because it made them rich... or richer.

Next I'd like to know how many Americans became poor from mortgage leverage.  Were they smart to use leverage to go bankrupt more quickly?

It's interesting how taking on a huge loan to buy a piece of property is considered "building equity", but if someone suggests borrowing money on margin for the stock market then suddenly we're crazy risky.  Yet both are essentially the same application of leverage, and it's a lot easier to buy & sell stocks than homes.