Keep all the equity in the house?

liz_hFebruary 26, 2007

My husband and I have just finished building our home. It is paid for, but ended up costing far more than expected at the start. We aren't real comfortable having this much of our capital tied up in the house, but can hardly see taking out a mortgage at our ages (50 & 60). Otoh, if we are going to take out a mortgage, it is my understanding that to do so in the next 90 days would allow us to treat it as "original mortgage debt", with all of the interest deductible.

I know that many investment advisers say to not have a lot of money tied up in your home, so that any appreciation comes to a smaller original investment, giving you a higher rate of return. BUT, we don't plan to sell this house, and don't live in a part of the country where property values increase astronomically in a few years. We do itemize, so the interest would be fully deductible. I'm not real confident that we could invest the money and earn a higher return than we would be paying - certainly not before taxes. And then there's the matter of monthly payments. Making payments on a mortgage would require working more than we really want to in coming years.

I know that I haven't given you enough details for you to give advice here. What I would like is suggestions of things to factor into this decision.

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The big picture holds your answer. Do you have enough in emergency funds, retirement savings, job security?

If one of those has you really nervous now, leveraging your property could make sense to address that need. You could deduct the interest, but that is only part of the interest you'd be PAYING to access that money. So there is a real cost to you. Is accessing the money worth that cost? Would setting up a (also deductable) HELOC do enough to provide greater security without taking on any debt unless it turns out you need money?

Some on this board say that it is best to own either all your home or very little of it. The thinking is that any mortgage makes you vulnerable to losing the home in a forclosure, so might as well park money elsewhere where it isn't vulnerable - and if you put it in tax favorable vehicle all the better. And there is the argument you noted already that the annual increase in your property value is a higher % return the less you have in the house. (The leverage argument concerns me as it discounts the traditional goal of home ownership in favor of a portfolio - not sure that is so good on a couple different levels...)

But even leverage oriented folk agree that owning your home outright is the most secure situation. OTOH, you can't eat the shingles.

So back to the first sentence.

Maybe a HELOC available in the wings while you build up sufficient equity elsewhere (security) using those monthly mortgage dollars?

    Bookmark   February 27, 2007 at 12:46AM
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At your ages and since this is your forever home, I would take the security owning it free and clear and taking any extra funds for investments geared to your age and retirement plans.

    Bookmark   February 27, 2007 at 3:13AM
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How many dollars do you gain by having deductible interest?
Is it worth risking the loss of your home?
How is your health? Have you had complete physicals?
If one of you had to spend a few weeks in the hospital, how would you pay for it?
Do you need money now? Why? Credit card debt? Other debts? If you have such debts, are they secured or unsecured? Credit card debt is unsecured: If you don't pay, you don't lose property. Mortgage debt is secured: If you don't pay you lose your house. If you need to pay off unsecured debts, do not use your house or other property for leverage.
How good are you at investing? Do you know any "experts?" If so, is their performance better than typical index funds? How would you invest? How about a nice no-load Vanguard fund? Do you think this would be a good idea? If you don't know the answer, stop. Start over. Hire a financial planner who is paid a flat rate, not a commission. "I don't want a financial planner," you say. Make some phone calls. Get one. Check out this website: Copy and paste it to your browser address window.

    Bookmark   February 27, 2007 at 8:28PM
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Are you both still working? Are you in good health? Do you have emergency funds?

The concern seems to be that you have too much capital tied up in your home, but if you are considering retirement in the foreseeable future, owning your home outright is huge. I sure as heck would not take out a mortgage if it weren't absolutely necessary.

DH and I just finished building our "forever" (well, hopefully "forever") home. Like you, it ended up costing more than planned and we have a mortgage that is about 1/3 the appraised value of the home. We took out a 15 year 5.5% fixed mortgage and are making biweekly payments on it. Because the payments are biweekly, the house will be paid off in 13 years instead of 15. We could take funds from our nest egg and pay it off, but DH is still working and the nest egg is earning more than 5.5%, so it doesn't make sense for us to pay it off.
But, if we did own it outright, I sure would not take out a mortgage.

    Bookmark   February 27, 2007 at 11:35PM
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I'm always concerned when people have most of their money tied up in their home. What would you do if you needed that money ASAP? You would have to wait for the sale of the home.

Timing is the issue here. As long as you could get a mortgage rate for less than earnings from investments, then I would take out a small mortgage to give me the choice to access the money without having to sell the house.

Our current mortgage is a 15 year fixed at 4.6%. Even simple CDs are doing better than that, so we choose not to pay off the mortgage. But...we want the security of a paid in full home for our old age, so we do pre-pay $300 a month on the principal. We'll have a 15 year paid off in around 10 years. That's a good compromise for us to have use of the funds and make some addition money.

As with most things in regards to depends.


    Bookmark   February 28, 2007 at 4:12AM
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Actually you would not HAVE to sell in order to obtain funds from your home. In a dire emergency, you could obtain a HELOC.

As Gloria pointed out, it depends...

    Bookmark   February 28, 2007 at 8:13AM
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I posted a somewhat similar question a week or so ago in relation to refinancing, with the majority of responses saying we should not refinance. We are still not decided, but are going to wait at least until after April 15 before making any changes.

And BTW, I'm not sure about this, but wouldn't you have to NOT be in dire straights to qualify for a HELOC?

Here is a link that might be useful: Discussion on refinancing and equity

    Bookmark   February 28, 2007 at 12:23PM
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I'm confused.

You just finished building a house, for cash. But now you're concerned because you've used up most of your cash cushion, so are wondering about taking out a mortgage to be sure there's cash around. Is that it?

If so, then I'm not sure what the problem would be in taking out a mortgage. Yes, it'll cost some money, but interest rates are still pretty low. And there's no law that you can't change your mind and pay the loan off at any time (assuming you've chosen a loan w/o prepayment penalties). Take out a mortgage, put the proceeds in a selection of Vanguard funds (making sure to diversify between lge/small cap, US and foreign, stocks and bonds) and the loan won't cost you much at all. Say you get a 6% loan, and earn 5% in your investments. It's costing you an interest rate of 1%. Worth it for the peace of mind of having emergency money handy.

    Bookmark   February 28, 2007 at 12:46PM
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Now, housenewbie, that's kind of what I was asking in that earlier thread. Our situation is different from the OP's here, but the principle is the same.

However, in your example, it would actually cost more than that 1% because they would be paying taxes on the 5% earnings, right?

    Bookmark   February 28, 2007 at 1:16PM
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"However, in your example, it would actually cost more than that 1% because they would be paying taxes on the 5% earnings, right?"

More complicated. They would be paying taxes on their earnings, but reducing taxes (if they itemize) due to the mortgage interest.

    Bookmark   February 28, 2007 at 2:48PM
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If you start from owning your home free and clear, you own 100% of your home, no one is going to have a claim on it.

If you own 50%, taking out a loan, with guaranteed requirement to pay interest on the loan, you have your neck stuck out quite a bit ... what did you do with the money? Buy consumer stuff? That way, you're eating now - and paying later ... plus paying fees on the future(?) income not yet received, with no outside income to help cover it. And no extra assets to maybe produce income, maybe grow some.

Not my cup of tea.

If you use the money to invest, neck stuck out some. You have guaranteed requirement to pay interest on the loan. You have some extra assets, whose value may grow - may shrink. If your investments produce some income, that can pay part of, or even all of the cost of the loan (net of tax considerations).

If you plan to take out a mortgage for, say 1/4 of its value, neck stuck out less far ... what do you plan to do with the money?

Invest it in a bank account or Money Market instrument, that usually pay at a low rate, to obtain the peace of mind of knowing that you can cover an emergency need?

How about taking out a HELOC, say for $20,000. if that's the amount that you'd like available for emergency ... but it may be that there'll be set-up fees. Then not using it till there's an emergency. Will there be fees asociated with letting it lie unused?

Plus, how about holding a no-fee regular credit card, planning to use it for immediate emergency, then drawing on the HELOC to pay off the credit card debt before due date, in order to avoid their high interest rates - thus deferring the date at which interest starts on the HELOC, and carrying it at a modest rate?

No interest to pay to anyone, or worries about differential rates, until you have an emergency. Interest cost not deductible, though, I expect.

If your regular card has a low limit, can you feel comfortable with that until they increase it, as they usually do after a time? If so - there's the HELOC available to draw on immediately (paying interest from that date), or you can take out a second card.

*Never* let that/those higher-limit card(s) out of your sight - even to give to waiter at a restaurant, for internet purchases, etc. - carry a card with a very low limit for such uses.

If there are (substantial?) fees associated with setting up a HELOC, what about taking a mortgage (comparable set-up fees? deductible interest, for next ninety days - your suggestion?) for, say $50,000., then either investing mainly in quality equities, aiming at leaving the mortgage running for a substantial time, giving a long enough period to allow for the equities to appreciate over time, despite short-term fluctuations.

When using the mortgage to purchase income-producing investments, interest is usually deductible, I think - you need to check it.

Using a HELOC for investments, you may well be able to arrange to pay interest only on a regular basis, with option to pay down principal as you choose; using a mortgage won't give you that option, so you'll have much higher ongoing payments liability.

If you invest in equity-based mutual funds, the market historically has average growth of about 8%, and U.S. mutual fund managers usually charge about 1.5%, I think - about 18% of your anticipated growth rate ... and they get theirs annually, whether the market goes up, down, or sideways. Perhaps buy Exchange Traded Funds, which buy various components of the whole market, but managers charge much lower ongoing fees.

Very few fund managers manage to out-perform the market, long term.

On the other hand, with about $60,000. to invest in total, you could buy stocks directly, in various market segments, countries, probably 6 - 10 to a dozen or so, more or less building your own mutual fund - and avoiding their substantial ongoing fees (pocketing them instead). And if your rate of appreciation is slightly lower than that of the fund managers - you're not paying their guaranteed fees, either.

Use the original $50,000. to buy stocks or equity mutual funds (with some bonds, etc. if you'd feel more comfortable, but those dollars don't grow if left to maturity, and inflation erodes the value of each dollar annually).

Using your $50,000. invested using the mortgage/HELOC money in those mutual funds, ETFs, bonds and stocks as underlying security, open an LOC for $20,000.00.

I think that you'll find that the lender is willing to lend $50.00 on $100.00 of underlying collateral.

I took out a fully secured LOC a few years ago, covered by stock and mutual fund certificates, with no set-up fees. There are no fees associated with carrying it unused, either. You may be able to arrange such - check, of course.

Using a LOC for $20,000., should your $48,000.+ (net of commissions) asset, supporting a LOC of up to $24,000.00, drop in value by about 15%, you would still have value to cover your $20,000. LOC if it were fully drawn, but no problem, as it is lying there unused, ready to cover you in case of emergency.

However - if there's a further drop in the market (which sometimes happens - up to 25% or so), if your LOC is fully drawn, your lenders are going to want more cash or collateral - like, today, or tomorrow at the latest. That is - *only if* you are using the full amount of your LOC at the time! Otherwise, you're covered in case of a deeper market drop.

Suppose you use $10,000. of the LOC to buy more equities, leaving you with only $10,000. unused portion of your LOC? With about $58,000. in assets underlying the LOC, if the market drops by slightly over 25%, you are still covered for the full amount of the LOC - which is usually only drawn to $10,000., except when in use for emergencies. And there is back-up of the credit card(s) that can be used, even if one needs to carry a balance at higher interest rate for a while until there is some free room again in the LOC when markets recover.

Those $48,000. - 58,000. in assets will produce some income which you'll need - plus other ongoing money - to cover the costs of the interest and principal on the mortgage and interest on the HELOC (or portion thereof) when in use.

As the value of the stocks increase over time, the amount of the dividends will usually increase slowly, resulting in a reduction in the funds required from your ongoing income.

Also - the amounts that you are required to repay are precisely the amounts that you borrowed in the first place (apart from the rent on the money).

That, so long as inflation is with us (as it has been since the Dirty Thirties) you'll be repaying in deflated-value dollars.

The guy/gal who puts his/her money in the bank in guaranteed-value dollars loses to inflation ... while the guy/gal who borrowed them, paying back precisely the amount that s/he borrowed ... gains.

At about 2% annual rate, currently, isn't it?

Good wishes for making a decision that you're happy with, long term.

ole joyful

    Bookmark   February 28, 2007 at 4:52PM
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Now, housenewbie, that's kind of what I was asking in that earlier thread. Our situation is different from the OP's here, but the principle is the same.
However, in your example, it would actually cost more than that 1% because they would be paying taxes on the 5% earnings, right?

Probably; alhtough, it depends. If that 5% is interest or dividends, then yes, there are taxes (at various rates). If it's in appreciation of assets, then there's no tax until you sell the asset. And, If you're in the US you can sock away a few thousand each year into an IRA, thus decreasing the amount that's taxable. It still would cost less than the face value of the loan.

    Bookmark   March 1, 2007 at 12:44PM
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I want to thank everyone for your comments. You've raised some good points. Right now I'm too tired from moving to do much real thinking! I am taking the time today to jot notes to myself on the points you've raised. Some are easy to answer - some not so easy. As Gloria said "As with most things in regards to depends." (sigh)

We are in Texas, and (like any other state) our state laws and taxes also factor in our decision.

The biggest buggaboo is inflation. If I didn't hope to live to a ripe old age I'd be less concerned!

I should be posting back on this in the near future. Thanks again, everyone. You've been a lot of help. I welcome any more thoughts anyone has.

    Bookmark   March 1, 2007 at 3:26PM
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So what did you decide

Interesting analysis, especially the inflation angle, had not considered it

    Bookmark   March 16, 2007 at 1:31AM
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saphire, I decided to worry about something else for awhile!

Right now my rough plan is to continue to read and ask questions, then go to see a fee-based financial planner and walk through all the details with him/her. I'll probably try to set an appointment for about 3 weeks out because I would like to have any loan in place soon to take advantage of the 90 day limitation for original mortgage debt. (See the OP)

    Bookmark   March 16, 2007 at 2:14AM
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Ole Joyful says:

"If you invest in equity-based mutual funds, the market historically has average growth of about 8%, and U.S. mutual fund managers usually charge about 1.5%, I think - about 18% of your anticipated growth rate ... and they get theirs annually, whether the market goes up, down, or sideways."

The sense of these numbers is about right, but the numbers themselves are slightly too pessimistic, I think:

1) The US stock markets have typically done better than 8% on average, if you include reinvested dividends.

2) Although many mutual-fund managers charge as much as 1.5%, there are many who charge much, much less.

As an example, consider the Vanguard 500 Index Fund, which I believe is the oldest retail index mutual fund. As its name implies, that fund tracks the S&P 500 index, and does a pretty good job.

Its expense ratio is only 0.18%. If you are willing to invest $100,000 or more, there is another version of the fund with an expense ratio of only 0.09%. So you don't have to be eaten alive with expenses.

What about returns? Well, this particular fund, which is a good representative of USA large-cap companies, has returned an average of 12.14% (after fees) per year since its inception in 1976. Over the past 10 years, which includes the 2000-2002 bear market and subsequent recovery, it returned an average of 7.55% per year.

If you want to be even more diversified, Vanguard has another fund (VTSMX) that tracks the entire USA stock market. So your returns are the returns of the entire market, less expenses--which in this case are 0.19% per year (or 0.09% if you can ante up $100,000). Since its inception in 1992, it has returned 10.78% per year, or 8.03% per year for the past ten (again including the 2000-2002 bear).

Now of course, it is much easier to predict the past than the future, and all investments involve risk. My main point is just to say that you don't have to pay 1.5% in fees, and I think that 8% is too conservative an estimate for USA past stock-market growth.

One more example. The Vanguard Wellington fund, which actually predates Vanguard's existence, was founded in July 1929--just before the start of the Great Depression. It is an actively managed blended fund--that is, it holds a mix of stocks and bonds--mostly stocks of large companies that the fund managers think are undervalued, and medium-term investment-grade corporate bonds. Right now it's about 65% stocks, 35% bonds, but that changes. Its five largest stock holdings at present are AT&T, Bank of America, General Electric, Citigroup, and Chevron.

Since its inception, this particular fund has returned 8.41% per year, including the Depression years. Over the past 10 years, it has returned 9.37% per year, including the recent bear market. Despite being an actively managed fund, its expenses are only 0.3% per year (or 0.17% for balances over $100,000). Note that because this fund is part bonds, it is less volatile than an all-stock fund would be.

In short, I think (or at least I hope!) that going forward, it should be possible to do substantially better than a 6.5% return (which would be 8% from the market less 1.5% in fees) from stocks.

Of course, I could be wrong. Ya pays yer money and ya takes yer choice.

    Bookmark   March 16, 2007 at 9:55AM
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