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Limiting Home Equity to no more than 25% of Appraised Value, WHY?

Posted by saphire (My Page) on
Tue, Oct 31, 06 at 12:21

someone responded to a post on the Buying and Selling Forum about taking out PMI or doing an 80/10 mortgage as follows

How long you actually stay in the home is irrelevant. What matters is how long you keep the existing loan structure itself in place. For significant reasons of safety, liquidity, and net-worth growth, Financial Planners now recommend that your real estate equity be seperated from the property and rebalanced to safer investment accounts whenever your illiquid equity reaches 20-25% or greater. In most markets, even during "slow appreciation" periods, this occurs between the 3-6th year, at which time avoiding a refinance will actually end up COSTING you money, as well as incur greater unnecessary risks
I will link the entire post including my response where I questioned how you can do this if your income is not commensurate with a higher mortgage amount or you are vulnerable to moving sometime in the next year or two but do not have a definite timeline so the closing costs could potentially be a waste

I am curious as to what others think

Here is a link that might be useful: Home Equity Post


Follow-Up Postings:

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RE: Limiting Home Equity to no more than 25% of Appraised Value,

If I read Dave right, appraisal and % of appraisal are both irrelevent. He is saying one should limit the home equity piece of net worth to no more than 20-25% of total net worth. Meaning: shift money out of your appreciating home (via a refi) and put it into other investments. The argument is that you are then safer and better balanced.

Dave speaks from inside the business, and obviously, doing what he says supports the financial industry made up of mortgage and investment brokers. Grain of salt taken. But he is trying to make a reasonable point that too much home equity (illiquid) vs. other resources (more liquid) is not a great idea. Eggs in one basket and all.

Personally, I think the truth is in the middle. I agree with him that it may not make sense to prepay a mortgage instead of funding retirement accounts. I disagree that equity should be routinely be pulled out of a house to fund investments (though that'd be smarter than pulling out equity to service debt or to live large as too many have done.) In his scenario, you'd be paying a mortgage until you were sitting on a (liquid) net worth 4 or 5 times the value of your home! Again, very good for the financial industries, and arguably a viable strategy to generate the most wealth in the long run. But never gonna happen for most people. Especially in expensive home markets.

Me, I'm old fashioned, and I really want to own my home. And I plan to get there in a few years. But my other investments are meanwhile fully funded. The home ownership goal wasn't instead of other saving, but in tandem with other saving.

The secret? Simple: live *well below* your income.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Thanks for your response

I agree that it makes sense to fund a 401k etc before paying down your homes equity, especially if its on a fixed loan where the payment does not change.

I guess it sort of makes sense if you walked into your home putting 20% down and after a number of years you are at 30-40% equity to pull part of that out so that you can sock it away somewhere. Here is where I have the problem, if your house did not appreciate at all, you are essentially refinancing the same amount as you did before and in theory your payments will be the same. However if your house has gone up in value, whether you then charcterize it as a percentage of your net worth increasing or the house itself appraising for more its the same if its been a sharp increase. BTW I thought he was speaking as to the value of the house not the overall net worth but either way. So to get to 20% equity either as net worth or as home value (pick one) on a house that has appreciated 50-100%, you have to borrow more than your income can cover on the loans. Where do you put that money (that you really do not need right now) so that it generates a safe income stream to pay off the loan at 6%. If anyone could safely generate 6% on their money why would banks lend it out at that rate?

Further this scenario works if you go in only putting 20% down however, some of us would not be happy with the house we could get for 20% down and the conventional loan amounts. So we may walk in putting 50% down. Again we could not put less than that down unless we had someplace to safely park the money to generate an income stream to pay off the part of the loan between 20% and 50%


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

I agree completely with your thinking. You are seeing the underlying worrisome parts of the poster's wealth building recommendations. I like your instincts. You are questioning how you'd clear the increased debt, while he is focused on reallocating your assets. He is promoting high-flying juggling and leveraging beyond what you are comfortable with. So run.

I'm getting old enough that I've seen a number of investment strategies rise and fall. Everybody knows about the fairly recent tech wreck in stocks, and the current real estate troubles. But those are just the latest in a long line of ups and downs - back to the legendary wild speculating in tulip bulbs.

I learned my lesson in the 1980's when the "hot" wealth building wisdom was to invest in universal life insurance (investment type, not term). The premise was to pay huge premiums, rack up huge "cash value", the premiums would 'vanish', then you'd borrow against that escalating tax sheltered cash value, deduct the interest, and come out way, way ahead. I still have the wacky printouts that laid out the ever growing balances (hundreds of thousands in equity *and* in parallel loans.) It never quite made sense to me from the start. And I got more and more frustrated trying to get somebody to explain the investment, especially why the premiums wouldn't ever "vanish" as promised.

Those papers came in handy years later, along with my copies of letters and phone call logs, when the class action suit went down. I opted out of the class, submitted my separate claim and ended up with an excellent cash settlement.

Lessons:

-Never invest in something you don't understand fully.
-Beware of investing in what seems illogical or counterintuitive. (You are smart enough to understand! So it has to be the deal. Run)
-Know that tax laws and regulatory changes can upend a viable investment strategy. Brutally.
-There is always a new angle. The financial industry will morph to survive.
-Some people will get really, really rich in the hot "new" financial angle (?next up: "Leverage")
-Most people will not. They get in too late and the landscape shifts due to changes in markets, tax laws, etc.
-What separates the two groups is just luck, timing and/or inside information.
-The true movers and shakers know stuff we never will.

Again, I say trust your instincts on this one. But I am conservative and debt averse.

And I am also curious what others think of this "optimal leverage" approach.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

I agree with all the above points, but also have a another point of view.

I will explain my concept.
I have about $500,000 to be used for investments.
I can use it several ways:
1. Pay off a 5% home mortgage to save the monthly mortgage payment of $2,600, ($31,200 annual). This will give me instant guaranteed 5% fixed return value of 10 years interest savings $228,798. I can invest this to increase my return (as with the other options), but I will lose the tax deduction on my low interest expense and will pay tax on the investment income, therefore reducing my yield. Loans for a personal residence have the lowest cost and interest rate. But the sleep factor is great for those that are risk adverse. I did not factor in appreciation because the assumption is the property is already owned, it will appreciate regardless of financing.

2. Buy rental property for $500,000, paying cash, giving me an estimated monthly rental income of $2,200, estimated 6% annual rental increase value of 10 years net income (cash flow) - $208,047, value of 10 years taxable income $64,411, (note the value of tax depreciation) estimated 6% appreciation on $500,000 increased value at 10 years $395,424. With my initial investment of $500,000, at ten years my return on investment is $603,471 (rental income and appreciation), without financing I cannot use that appreciation, unless I sell, possibly incurring taxes.
3. Buy rental property for $1,500,000 with $500k down, financing $1,000k @6.5% = $6,321 monthly payment. My estimated first year gross rental income is $144,000, estimated 6% annual rental increase value of 10 years net income (cash flow) is $507,690, value of 10 years taxable income $232,656 (again, note the value of tax depreciation) , estimated 6% appreciation on $1,500,000 increased value in 10 years $1,186,272. With my initial investment of $500,000 at ten years my return on investment is $1,693,962.

#1 is a good option if home ownership is important, it is not to me but I understand the want of that for other people. #2 is a good option for those that own their home.. #3 using debt as leverage appears to be the best option for me, meeting my long term goal for future income as a hedge against inflation with financial security.

Is there any risk involved, absolutely. Is the risk understandable and measurable, can I live with the theoretical risk that every tenant will move out and no one will ever want to live in my building, yes, historical data tells me the chance of this is nil. Can I live with vacancies, yes, the industry stand of 5% vacancy rate is factored in the above models. Option #3 actually decreases the vacancy risk; I am able to buy more units, so each vacancy will not significantly affect my gross income. Does historical data tell me my property may depreciate more than my investment, no; since I do not plan to sell soon, the short term fluctuation is not an important factor. Option #2 has lower taxes and insurance but higher management fees; this is factored in the options. Do I know my loan terms, and accept them, yes. Multi-family loans are not fixed for thirty years (not the ones Ive seen), so I factor that risk, being an investor, if terms are good in five years I would likely refinance to pull out cash (tax free) to buy another property, but to lower my risk factor, I use a ten year model to make a decision. One great benefit not discussed earlier is the great tax benefit of depreciating the property. Our tax system has always favored the real estate owner, fair or not, it is a fact. Our tax system allows me cash flow income with a much lower taxable income, at the risk of angering those that go to work everyday, making less but paying more in taxes, I can only recommend researching the tax consequence of every financial decision. I used to pay more taxes on less income, so I know it is frustrating. My goal is to reduce my taxable income but allow myself cash flow; real estate investing does this for me.
In this country we also have inexpensive access to money, this is one factor that has helped our country grow, giving many people the security of homeownership. Easy access to credit can be misused, but that does not negate the good use of leveraging. I find using leverage enables me to purchase good, clean property in an established area with diversified employment. By using leverage I am able to buy more units greatly reducing the cost per unit and spreading my risk. I do not advocate no or low down financing or anyone without secure employment and adequate cash reserves consider such an investment. Many leverage models use 90% financing; with that amount I could buy three properties, greatly increasing my return on investment, but it is too high a risk for me. In the past ten years the appreciation amount of 6% as shown above is about half of what appreciation has been in most of the USA, but I do not believe the high appreciation will continue. 6% is the appreciation average for the last twenty years, a good realistic average expectation, unless one plans to sell (which I dont) the normal ups and downs of the real estate market will not concern a long term investor. This is not a "get rich quick scheme", with short term (high risk) financing; this is years of researching and investing. I have considered and rejected more properties then I have bought, last year I spent $3,000 inspecting properties that I later rejected. You may say I dont have $500,000, but this model works for any amount I scrimped and saved to buy my first home, then the next and so on. Years ago, we painted, cleaned, did all the rental management ourselves, so the same can be done over time starting with little money or partnering with someone else. I have partnered with other family members to help them buy their first home. I used the amount of $500,000 because it is an amount that I have had available from the sale of property in the past and did this type of study to determine how it should be invested.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

You do not have to refinance your 1st mortgage to get the benefits of being able to access the equity in your house. You can add HELOC that does not cost you anything unless you use the money but at the same time is available for use in case you need or want to use it.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

"You do not have to refinance your 1st mortgage to get the benefits of being able to access the equity in your house. You can add HELOC that does not cost you anything unless you use the money but at the same time is available for use in case you need or want to use it."
Yes, it is cheaper to get, usually free costs, but the interest rate is usually higher. Both options just need to be weighed for each decision.


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RE: my first post

Oh, I meant to add to my above post, I used the value of $500k because I live in CA, prices are much higher, you can do the same math with a figure of $50k, I know appreciation varies in each area, but the point is the same, leveraging your money gives you a bigger return on investment. RE offers you big tax advantages that other investments do not.
celticmoon gave the best advice: Never invest in something you don't understand fully.
Actually, all her "lessons: were very good IMHO. My approach is just less conservative as I am less debt averse.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Thanks, cmarlin. This discussion is so interesting, and you make a good case for leverage. Several friends that have taken your route do complain a lot about tenant problems, maintenance problems, eviction problems - on and on. I know you have figured in vacancy rates, etc, but it is hard to put a dollar cost on those other headaches.

Some quibbles and questions:

Are you personally managing these properties? Are folks calling you in a plumbing crisis or are the costs of management/ colllections/ servicing/ maintenance built in somewhere? How much is that?

Does your area have high property taxes? Around here, the annual 1.5% of property's value would really chomp into profits. That $500,000 property generating $2200 monthly rent would have about a $625 tax bite. Per month.

Is a 6% annual rental increase really sustainable when overall inflation and salary increases have been roughly half that? Run that gap out over 20 or 40 years, and how would tenants' incomes possibly match up? Are you figuring your renting population will have 6% wage increases???

In scenario #1, my numbers say that investing the $2600 mortgage payment over 10 years even at a very conservative 5% annual growth ompounded becomes $405,415. Larger growth is not unreasonable with savvy investing, and there are tax shelter options. Done right, I think it can rival your #2 outcome with much greater diversity and liquidity - and fewer headaches.

Your scenario #3 is certainly compelling. Your plan is well thought out and seems sound enough. I agree the risk for a loss is minimal and the tax benefits are excellent. I'm not as convinced that the 6% annual rent increases and the 6% annual property value increases are a sure thing. But you will likely do OK even in a stalled economy. Perhaps not the 1.6 million you anticipate, but certainly OK.

Last question: the post triggering this thread advocated leverage, but also safety and diversity. Are you fully invested in real estate, or do you see need for a balance?

Lots of questions, but I am interested in your thinking. I don't mean to hijack, Saphire- I think we are still on topic.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

my HELOC rate is LOWER than my mortgage rate.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Beside with HELOC you pay interest only on the portion that you need/want to use, not the whole available amount.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Is anyone advocating only a refi? Is that on the b & s thread?
I believe both types of loans have their place.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

These Financial Planners offering this advice ...

... they're fee-only folks, are they? The kind that charge by the hour for their expertise but sell no financial products?

The guys who sell stuff frequently talk out of both sides of their mouth - one side is good advice for your situation ... the other side is what is really best for them.

Trouble is - which side is which???

Learning how money works - a good hobby ... that pays well.

And if the value of the real estate goes down 20% or so?

Many maintain that real estate values in many parts of the U.S. are due for a major correction.

I don't like margin calls - even when I have other assets to add to the security in the lender's hand.

Have a great weekend, everyone.

ole joyful


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Hey ole joyful,
Can you tell me what you are saying in plain English for dumb ole me?
I will have a great weekend, you too!


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Some quibbles and questions:

"Are you personally managing these properties? Are folks calling you in a plumbing crisis or are the costs of management/ colllections/ servicing/ maintenance built in somewhere? How much is that?"

I manage a SFR, but all the apartments I own have onsite manages and offsite managment. The offsite management fee is 5%, the onsite gets free rent. The one I manage is a high value house ($7,300 mo)that has no tenant problems, I co-own a duplex and triplex with my children to get them started, they manage our tenants. For the first time my tenant called me with a plumbing leak, I told her to call her own plumber then deduct the cost from her rent next month.

"Does your area have high property taxes? Around here, the annual 1.5% of property's value would really chomp into profits. That $500,000 property generating $2200 monthly rent would have about a $625 tax bite. Per month."

In CA, our prop tax is just over 1% of purchase price, the taxes increase over the years, but never catch up with the increased value, that is one reason why I am reluctant to sell.

"Is a 6% annual rental increase really sustainable when overall inflation and salary increases have been roughly half that? Run that gap out over 20 or 40 years, and how would tenants' incomes possibly match up? Are you figuring your renting population will have 6% wage increases???"

For my apartment rentals I did much research in the area, learning the employment opportunities , and housing opportunity. I buy in areas that have solid long term industries, well developed cities, not in new outlying areas with new construction to compete with, my apartments are more blue collar, middle of the road income, well maintained, but not competition. I've increased rents 10% for several years, my figures are long term averages. My SFR was $6,300 for two years, I then increased it to $7,300, which is actually under market, I believe I could rent for $7,800.

"In scenario #1, my numbers say that investing the $2600 mortgage payment over 10 years even at a very conservative 5% annual growth ompounded becomes $405,415. Larger growth is not unreasonable with savvy investing, and there are tax shelter options. Done right, I think it can rival your #2 outcome with much greater diversity and liquidity - and fewer headaches."

It is too early in the morning for me to think of this one, but are you saying that after paying off the mortgage you will then start investing the $2,600 monthly into a conservative 5% investment? I need to find my handy excel spreadsheet for computing all this. :)

"Your scenario #3 is certainly compelling. Your plan is well thought out and seems sound enough. I agree the risk for a loss is minimal and the tax benefits are excellent. I'm not as convinced that the 6% annual rent increases and the 6% annual property value increases are a sure thing. But you will likely do OK even in a stalled economy. Perhaps not the 1.6 million you anticipate, but certainly OK."

I use 6% as it is the historical average, the SFR that I mention above, has already more than doubled in value in four years, even if we stall for the next four years, the nubmers are good.

"Last question: the post triggering this thread advocated leverage, but also safety and diversity. Are you fully invested in real estate, or do you see need for a balance?"

I am mostly invested in RE, but I see balance as a good thing, and certainly know these above scenarios do not work for everyone. Many people simply do not enjoy the business aspect, I do enjoy it and make money in the meantime. But as I've researched RE, I really see it as low risk, property has never lost value over the long term, it is the short term risk I need to be aware of, I do not buy for the short term.
One point about your 5% investment above, I am more of a risk taker, but one thing that scares me is inflation. Some safe, but low return investments give me cause for panic 20 years from now. I do not want to lower my standard of living as I go into the "golden years".
I do you enjoy any feedback as I am always questioning my decisions, reviewing them as things change.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Thank you cmarlin, for all your answers. Helps me see how this is working for you. Very interesting.

I used 5% just as a conservative minimum return estimate in scenario #1. Me, I'm comfortable with a little more risk, so I have aimed for higher returns than that. I have done very well with Scenario #1 over a couple decades despite some bumpy times. I know the risks, and that such gains may not be there in the future. And actually, I did reduce my stock position quite a bit 6 months ago. Market has me nervous. I'm closer to drawing down and the risk is now less palatable to me than when I had a long time horizon.

I don't mean to be contentious, but I am still struggling with the ever increasing gap between recent 3% economic growth and the projected 6% rent increases in your model. I'll make up salary and rent numbers for an example: 60k salary, 1500 current rent. At 3% growth , that salary of $5000 a month grows to $9100 a month over 20 years, while your rent increasing at 6% climbs from $1500 to $4965. Your tenants go from paying less than a third of their gross pre-tax income (30% - very manageable, no?) to more than half (55%). Even a more optimistic salary growth rate of 4% a year has your tenants paying 45% pretax salary in rent 20 years later. After income taxes (another 20-25% minimum), utilities, and healthcare, that's not much left for food and tansportation - let alone any fun or savings.

I hear you that these numbers work going backwards in time, but how would that salary/rent gap operate far into the future? That's the part that troubles me. Seems to all hinge on comparable salary increases of 5% or 6%. Lots of us would like to see those!!

You have me thinking about real estate, but I am not sure it is right for me. I do appreciate your time and thorough explanations.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

cmarlin20,

A number of financial planners are really salespeople, frequently for mutual funds, or insurance. Many receive no salary, are paid mainly by commission. They talk to potential clients without charging them directly for the time involved and are compensated by commissions on sales. And, in many cases, by annual fees per holding, as well.

Some financial planners charge by the situation, or by the hour, for their time, but sell no financial products. They claim that they do not have a major interest in trying to convince a client that s/he should become involved with any of various investment systems, let alone one of a limited number that the salesperson just happens to sell.

Some have a basic charge for the use of their time, plus receive commissions on sales, and frequently trailer fees annually as long as the client continues with that investment (and the salesperson does - if s/he leaves, the fees revert to the next person above that salesperson in the hierarchy).

The fee-only people do have an axe to grind - they must convince the client that s/he is better off using them than not.

Some of us are interested in helping clients learn more about managing their own money, trusting that as they call less frequently, there'll be new clients who feel the need of the service.

The salespeople for mutual funds don't like to talk too much about the fact that, while long-term U.S. stock market averages have grown about about 7 - 8%, that few mutual fund management companies have developed a better record, but take about a fifth of that growth (up here in Canada it's more like a quarter).

Which may be useful for people with fairly small assets - but it seems to me wise for folks with substantial assets to learn how to manage their money effectively themselves, paying themselves much of those ongoing fees, so to speak.

And if, like me, you're retired and living comfortably on somewhat below the amount of your three pensions, let alone the payments from your tax-deferred retirement plan or other investments, you don't care too much if other clients don't happen to appear. I don't mind working myself out of a job.

At age 77, and having taken no pills for at least 30 years, I figure that every day is a good day. And a good day to give something back to the community, to help leave it a better place than I found it.

Good wishes for increasingly skillful management of your income and assets.

ole joyful


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

I read the link and the preceeding posts. I have to tell you, I'm not completely sure I understand the whole thought process! Just when I thought I "got it" someone would raise a scenario that confused me again.

We have guy who's worked with us over the past 12 years. He's "into it" and we have a good working relationship with him. He knows us, and knows how we think and operate our home. He's directed us to investments that are reasonably secure while producing interest income to be reinvested. When we've expressed interest in a particular sector he's been right on it, following up with options/risks.

I'll tell you what I told him a couple of weeks ago:

I know how to get up every morning and go to work.
I know how to keep the daily/monthly expenses low.
I know how to pay the bills on time.
Monthly investment money is just another "bill".
I'm informed on domestic and world affairs.
You like to ponder this stuff, I don't. You know how we think. Your commission is money well spent for me.

Paying our house off was a goal for us. We forewent savings to accomplish it (in a recessionary economy). We did all the finish work ourselves and given its location it is worth easily 6 times what we have into it. If we sold we wouldn't be able to buy anything comparable for 1/2 the price in our area.

I like knowing we owe NOBODY. I like knowing we have complete equity in such a valuable asset. And we've dumped our "mortgage payment" into savings/investments every single month since we paid off the note. In addition to "regular" savings.

I'm old fashioned. I like owning my house! And we still manage to save/invest enough to keep us on track. We have never succumbed to "live large" virus, though.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Chelone, I'm more in your camp than in cmarlin's or the leverage advocate's. I believe in owning a home outright as a first basic step to security. And I'd also rather be a "regular Joe" than "live large".

But I do kinda like the numbers stuff too. And after many burns and losses taking professional advice, I found I was better off minimizing costs and managing the money myself. I wish I could have found an advisor that I trusted that didn't have me hemmorhaging money while everyone else was maaking huge gains. I actually managed to lose money in stocks during the run-up in the late 90's! Some friends would ask what I was invested in just so they could do the opposite, it was that bad! You are lucky to have a good advisor.

I have looked hard for one and given up. I stuck with advisors through years of significant losses, then got out only when the firm was tanking. Twice. So it isn't like I'm paranoid or disloyal. My last stab was a couple years ago seeking to reinvest a large sum I'd pulled from a collapsing, scandal ridden firm. I had a half dozen meetings or so, all with recommended people. The insurance guy said I needed more insurance; the equity guy said I had too much insurance and need more (of his front end load) mutual funds; the fee only guys wanted to do a major long term plan involving everything (rather than speak to the money I wanted to reinvest), etc etc. Sigh.

It has been better since I took charge myself. Treasuries, my corner bank and the Vanguard type low fee funds have worked out much better for me.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

I work with another guy who oversees my SEP account, too. He knows I'm a dedicated investor, knows I strive to maximize contributions and minimize my taxable gross. He also understands that I "got a late start" and have been willing to go with a more aggressive strategy. He watches my investments carefully, knowing my age and temperament.

The same thing goes for the guy I referenced in the post above. He was stunned to learn that we own our home and that everything we've done/added/improved has been out of pocket with sweat equity (he told us candidly it never crossed his mind that the house was paid for, and that he'd never make that assumption again!). Once he understood that, he was johnny on the spot with several investment options for us. We sit down with him every quarter and go over the numbers, the current state of world politics, how we feel about it all. We have some "dogs" in the portfolio, but poor performers are identified early and we talk about what to do.

I HATE meeting with him. It's a struggle for me to wrap my brain around all the information, but I do my best. I'm not looking for huge returns (but like it when they arrive!), I'm basically conservative, restrained, and willing to accept moderate gains, all the while adding to the investment.

I have never purchased a lottery ticket in my life. "Get rich quick" is surely possible, but I'm not enough of a gambler to pursue it, and I don't work in field that lends itself to it.

I know how to get up, go to work, keep the expenses low, and SAVE/INVEST, little bit by little bit. I'm the quinessential New England Yankee...


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Sorry it took me awhile to respond, thanks for all the comments

Chelone I have lots of relatives who have a great retirement doing what you are doing. MIL struggled to put the kids through college on a teachers salary and now in retirement is rolling in it. Keep it up

I have no problem mortgaging or not mortgaging my own house. Our real estate taxes are high, probably more than many mortgages, so even if you got rid of a mortgage you are still paying 1k a month in taxes. In the above example, I probably would do option 4, if I really had a 5% mortgage I would not pay it off and probably stick part of the money in a CD paying 5.5 or whatever rate I could get above 5! To pay it off really would be leaving money on the table if you could SAFELY get more than that. I agree that Universal life is seldom a good deal and I would only do that if I thought from an insurance point of view it was a better deal than term for some reason. Otherwise I think its just a scam.

The problem I had with the post that started this, if you have a mortgage at 5% and now have some extra cash, great, do not park it in your house because you really can get more at the bank. However the advisor was suggesting pulling money out (does not matter REF or HELO) just so you have it in your hands instead of it sitting dead in your house. Thats a great idea but if I am borrowing at 6% and can only SAFELY invest at 5% who is going to pay the spread? Also what about the 10k in closing costs I paid to pull the equity out? Worse what if I do follow a hot stock tip that ends up not so hot?! People are tempted when they have acess to so much cash (I think I could manage but who knows). Dave claims its an issue of safety to have too much equity without owning it outright. The HELO that was suggested would actually be one way to safeguard the eequity. Do not tap it unless you really need it, the perfect storm scenrio that Dave mentioned where people cannot tap the equity and lost their house even though they have lots of equity

Thanks for the compliment Celtic, I just could not figure out how to adress the shortfall in an owner occupied property. Ia lso agree with you about the rental increase issue, 6% annally is impossible, office leases around here have a 3% increase, sometimes less.

CMarlin

I love your examples and you have given me things to think about. My DH thinks I am the most risk averse person on the planet so I doubt we will be competing for property (especially from NY!). In running your numbers why even invest the 500k? If your debt service at 6.7% is about 116k and your income is 144k, even assuming taxes are 20k why tie up so much? Do the lenders require this? Is it to give yourself a perfect storm cushion? Why not put aside 100k in an interest bearing acount instead and maybe put down 100k so you can cover incidentals with the rental income? I have no idea how this works. What is an SFR?

Also do you buy rentals locally? You mentioned you research the areas which assumes you go outisde of your local area, do you go out of state? Just curious. What about

I have Two real estate stories I think about that stop me from following your lead, I guess if prices really do drop in a mini crash maybe I will rethink it. Although there are still lots of people like me who know a bunch of people who recently got rich on real estate so we wonder if we could do the same and I always wonder about things everybody is doing, someone has to lose money doing it. Not saying you CMarlin I actually think your plan is sound except for the 6% but I assume even at 1 or 3% you will still make money (although how does that play into local tax increase, here they have been increasing taxes up to 6% PER YEAR based on the rapid increas in value of these properties). How many apartments do you feel you need to own when starting out to truly spread the risk so to speak? Also of the 144k, what percentage is overhead unrelated to taxes and mortgage. What are those expenses?

Here are the stories that stop me. In 1986 a wealthy physician I know (not well) decided to invest in real estate out of state in Boston. With the 1987 crasg the condo market went belly up and they could not sell these in the late 80s. He and several others were general partners. One of his relatives who got him into this ended up losing her law licsence over this! They tried to sue him and he almost lost everything outside of this (had a large home etc) fortunately most of his assets were in his wifes name anyway for liability reasons relating to his medical speciality, so they dropped the suit when they realized this. This same guy started trading stock on margin out of his retirement account in the late 90s, his account at one point was up to 42 million! Needless to say he is still working after that market crash and he is now near retirement age

My father was approached by his accountant in 1975 who was running a tax shelter. He and his partners were buying a building near Lincoln Center in NYC. At the time the neighborhood was a bad and they paid 1m for a 40 story building plus garage (400 per car per month) and retail stores in the lobby (now a Chase Bank, a drugstore and a McDonalds). Dads share would have been 100k but back then he did not have it and even if he did, well I get my risk averse thing from him! For some reason I remember telling him to invest but who listens to a 12 year old and again they really did not have that kind of money to throw out with 3 kids. In 1987 (yes at the absolute height of the market) I bought a last remaining sponser apartment in, you guessed it, that building for more than double what 10% of a 200 unit building would have cost 12 years earlier! This was a fluke dad did not realize it until he saw the purchase contract. They ended up selling the apartments back to the tenants for 10m in 1985! They kept the master leases on the garage and the McDonalds so I am sure that funded someone's retirement. The irony is this was sold as a tax shelter, it was not supposed to even make money!

Dad has no regrets (well other than that 4th child they never had!LOL) he says that for every successful deal he was offered, there were 20 that failed and he would have lost his investment

I know this is way too much information but its what makes me leary about real estate as an investment. I actually just want a bigger house for me and my household, I do not care if its paid off or not as long as I am not awake nights worrying about how I can pay the mortgage. Still trying to figure out how to get there

Its funny I flip flop on the do it yourself investing. I hate being told what to do and need to understand it before I can commit. I also hate mutual funds as a general rule excpet for the ones that are based on indexes. I sort of get frustrated with magazines like money that seem to try to make everyone feel like they need to be in mutual funds and not just one, but a portfolio of them,. Are they secretly owned by a constortium of mutual fund. Also I wonder what an investment advisor can tell me? Its like my theory on stock brokers, if they were so great at picking stocks why would they need me to make money. No offense intended to any investment advisors.

I do think an individual investor can beat the market average (or not!) even if they do not have access tp all the inside information because they have flexibility that a mutual fund running 1B does not. Then there are days when I look at my house which is basically decorated but the reality is that it lacks the fine tuning a decorator could give it but I hate the idea of living with something someone else has chosen for me(I tend to return gifts too). Its sort of like that with investing, I am not comfortable with the loss of control but I do not have the time and energy to follow this all the time


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

"The problem I had with the post that started this, if you have a mortgage at 5% and now have some extra cash, great, do not park it in your house because you really can get more at the bank. However the advisor was suggesting pulling money out (does not matter REF or HELO) just so you have it in your hands instead of it sitting dead in your house. Thats a great idea but if I am borrowing at 6% and can only SAFELY invest at 5% who is going to pay the spread? Also what about the 10k in closing costs I paid to pull the equity out?"
saphire
When getting a HELOC, you should not pay $10k to get your money. I agree borrowing at any rate is not wise unless you can make more moeny investing that borrowed money. 5% firsts mtgs were common a while ago, not now. sadly


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

I think the OP talked about refinancing to get your money out so it would be about 10k to get 500k out in my area because we have lots of recording fees


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

saphire: funny stories, or not so funny depending on your perspective!
I don't know about the 6% increases, I know we've been increasing our rentals more than 6%. That may be regional. I tried to find a schedule on the net of average rent increases but didn't. Maybe a little lower is a better conservative %%. I try to use realistic ##'s or it doesn't do me any good.
SFR is a single family residence as opposed to a multi-family.
Regarding the $500k down payment, I'm in Southern Califorornia, it is difficult in my area to buy a good investment for $100k down, multi-family's require a higher down, I think it is now 30%. When investing in multi-family, the more units (or doors) the less cost per unit. Therefore, it is in the investors interest to buy the biggest number of units one can. Generally multis are better to buy than a SFR.
Here in CA, the property taxes do not rise as much as the appreciated value of property so it is better to keep the property, that is one reason I don't sell. The big benefit for RE investing vs the stock market for me is taxes. Truth be told, I have good cash flow income, live a nice life, but have not paid income taxes for more than four years. I am able to take huge depreciation on my properties. I can't do that with stocks, even with mutual funds you may pay taxes on income you don't even receive, with RE I receive income but don't pay taxes on it.
I don't like life insurance in any form as an investment, I think term is good, if necessary, but otherwise it is not an investment to me.
I am also leary of any advice from someone that is profiting from my decision. It is not always bad, but who knows.
Did I answer all questions?


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

I enjoy looking at other people's ideas and plans, I'm one of those weird people that finds it interesting and fun.
To show you what a RE guru I am, I just saw on a RE site a small lot that I sold in 2000 for $40k. The now asking price with a note that its "under contract" is $250,000. Oh well, I think I sold a little too soon.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Saphire, Chelone and Cmarlin,

I am enjoying all your posts very much. Saphire, your father's stories reminded me of my Dad talking about passing on investing in the fledgling Kentucky Fried chicken. Then again, he also opted not to relocate our family in 1960 - despite the tempting offer of free tuition for us 8 kids - to a little out of the way place called Viet Nam.

Sometimes no move is a good move I guess.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Hi All,

Geez... have a party ABOUT me, and don't even INVITE me... sheesh... good thing I have thick skin (no... not "thick skull" thank you ;~)

Some folks here have understodd the financials of the topic, clearly some have not. Let me see if I can clarify & simplify;

A) Cash equals safety (as long as we can assume the person in question is responsible with money. Toss that assumption away, and it's a different conversation.) Cash trapped in real estate equity is about as unsafe as it can get, simply because it is at risk of being inaccessible.
B) It doesn't take a "perfect storm" to reduce your home value (losing the money you though was so "safe" as it was paid into the equity,) as many people in several markets across the country are discovering right now,
C) It doesn't take a "perfect storm" to find yourself the target of litigation, with the opposing attorneys performing "discovery" and licking their chops at the values they can place liens on in your home equity,
D) It doesn't take a "perfect storm" to have an uninsured natural disaster wipe away part, or all, of your home value... earthquakes, tornadoes, ex-spouses... all of this happens all the time. Fighting against insurance companies to make sure you get the best treatment is far easier when the money was already in YOUR bank account, instead of in the home equity that burned down or washed away in the mudslide.
E) It doesn't take a "perfect storm" to have family members (or yourself) fall into bad times and need money, caretaking, or attention. It doesn't take much at all to find yourself in a position where your credit, income, employment, and/or stability have shifted to the point where you cannot qualify to re-access the money you sent to the mortgage bank that you THOUGHT was yours...

The above issues are all about SAFETY... which is (or ought to be) the top decision criterion in any case.

After safety is addressed, THEN we ought to be looking at appropriate diversification and financial management for retirement. That is an entire new post... but suffice to say this; Home equity (as an asset class) is roughly equal to treasury bonds (though not as safe.) If/when you are a point in your career when you need to increase your BOND holdings, THEN it would be appropriate to transfer your growth oriented investments toward retiring your mortgage balances (assuming that makes better sense than simply buying bonds.)

At some point of home ownership, if you do not keep maintenance of the shifting balances between your growth investments, your tax-advantaged leverage (the debt that lets you own appreciating assets like homes and businesses,) and the growing equity of the homes themselves, you WILL grow out of balance. Imbalance can add risks, and cost real money.

The idea that owning your residence with more than 25% is out of balance is merely a conservative simplification... a "rule of thumb" for those who are responsible, disciplined and intelligent with their family finacnial planning. For younger folks who have yet to accumulate sufficient safety reserves and a growth portfolio, the number is likely to be far smaller.

Hope that helps to clarify ;~)
Dave Donhoff
Strategic Equity & Mortgage Planner

PS. implying that my advice is "industry" based is wrong, plain & simple. My intention is to share what I know and learn... I charge nothing for this here, and ask nothing in return.

PPS. fee-only financial planners (who make no commissions from their advice) are some of my greatest teachers and allies. My firm is actually launching exactly this type of non-commission service in 2007 as well. Most of my financial acumen comes from seeing through the fiduciary perspective of growing family wealth safely, and (hopefully) permanently.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Interesting.

1. 100% equity.
2. Plenty of "cash".
3. Plenty of long-term investments; including tax- deferred/tax-free retirement plans. Working with a good, smart planner has been a boon for us; he knows how we think and has directed us to investments that reflect that.
4. Debt-free. We live well below our means.
5. A good, trusting relationship with our insurance agent. Umbrella policies can deal effectively with litigation. Speaking frankly with our agent about our "worth" has been worthwhile.
6. Unforeseen disasters can be addressed with good insurance coverage, too; helps to have cash in the bank. It takes some thought, and some questioning, but any good agent is capable of this. (We've worked with our's for over 16 years now).
7. Caretaking! tell me about it, I've done it for going on 4 yrs. now... Mum. She lives with us. In those years we've isolated her home from appropriation for long-term care costs. Power of attorney and long-term care insurance. Never loan money to your family. "Neither a lender nor a borrower be".

We don't personally like the way the USA is heading with respect to fiscal matters. We like knowing we hold the "paper" to our home. We went "without" for a lot of years while our buddies were "livin' large". Now, they're sweatin' the bills (kids and college, looming retirement, and a mortgage) and we're starting to really relax and not "sweat" the lean times or the times when we're down with the 'flu and don't want to work.

Maybe I'm still missing the point? (I don't think so, though).


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ps: the biggie

Duh! forgot the biggies... a good, trusting, working relationship with an attorney and an accountant! Meet with them every few years/yearly... worth the money.


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RE: Limiting Home Equity to no more than 25% of Appraised Value,

Hi chelone,
Not sure which point you're afraid you are missing... but it looks like you're spot-on and in alignment with all MY points, anyway.

Have a wondrous Thanksgiving holiday!!!
Dave Donhoff
Strategic Equity & Mortgage Planner


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