mfbenson, taking out a mortgage on your home doesn't insulate you from any loss in its value. Even Dave admitted this above, Fri, Mar 14, 08 at 23:23. So I'm not even sure what is meant by "home equity is an investment". No matter how much or little equity you have, any gain or loss in the home's value is yours. Of course, mortgaging the house does give you the option of walking away from the loan and the house if it drops in value. Some people would find this morally repugnant, especially if you went into the deal with the intention of possibly doing it.

The long-term history of small-cap stocks, 13% or whatever it is, is *not* a safe return. That's what they mean by "past performance is no guarantee of future results".

I believe that a mortgage on your house reduces the amount of your "homestead protection" in case of bankruptcy. Could Dave or some other knowledgeable person comment on this?

"Ok, but if you pre-pay the mortgage you wouldn't have much in the investment portfolio in the first place, and you could still lose the house or its equity."

But you would definitely have more equity in the house than if you didn't prepay it. That makes it more likely that you would be able to sell it for enough to cover the mortgage balance. That would put you in a lot better position than if your depleted investments wouldn't cover it. You'd be forced to liquidate them and you still would be left with a shortage -- you'd have no house, no investments and a debt you'd have to pay off.

I also challenge your assertion that there are currently safe investments at rates high enough to cover the tax-adjusted costs of a mortgage. I've looked at current CD and annuity rates and I sure don't see anything that's liquid enough and carries a high enough rate to accomplish this for most homeowners with mortgages.

But maybe I'm overlooking something and you could point me in the right direction?

I started out in this thread by arguing with Dave, now here I am sticking up for him...

"mfbenson, taking out a mortgage on your home doesn't insulate you from any loss in its value."

Yeah, and paying down the mortgage doesn't either. The point isn't to make your house value immune to a bad market, its to put your money to work for you in the best way available.

"The long-term history of small-cap stocks, 13% or whatever it is, is *not* a safe return."

If by safe you mean risk-free, you're right. But if you are just trying to outperform the tax-adjusted cost of a mortgage, over a long enough time period, its a relatively smart bet. There are ways to outperform the tax-adjusted cost of a mortgage without taking on nearly that much risk though.

"Of course, mortgaging the house does give you the option of walking away from the loan and the house if it drops in value."

Technically you could do that even if you owned the house free and clear.

"I believe that a mortgage on your house reduces the amount of your "homestead protection" in case of bankruptcy."

As far as I know that varies from state to state.

"That would put you in a lot better position than if your depleted investments wouldn't cover it."

If your depleted investments wouldn't cover it, you would have either been investing in something so risky that it may as well be the crap tables in Vegas, or it was such a small amount of money that using it towards the mortgage wouldn't have much much difference anyway. The point is to put the money in something still on the safe side but better performing than home equity.

"But maybe I'm overlooking something and you could point me in the right direction? "

Short answer, universal life, somewhat less short answer, single-payment annuities are paying between 4% and 4.7%, are worth 5% to 5.9% if tax deferred, whereas a mortgage at a competitive rate of 5.8% is costing 4.35% after taxes (less if you're above the 25% bracket). Ok, now the caveats: You might have to pay surrender charges on whatever portion of an annuity or insurance policy you liquidate to cover a sudden financial emergency, so this strategy isn't for everyone, but if you feel such an emergency is not likely I think its worth investigating. Plus there can be an extra bite tax-wise if it was a tax-deferred annuity.

All that said, I am not 100% against occasionally pre-paying on a mortgage, but my thinking is that it would only be done to keep the home equity in proprotion to other investments, whereas the type of "investor" that Dave is most worried about is the person that wants to pay off the house free and clear before even beginning to save in other investments. Even the consumer reports article says it "rarely" pays to pre-pay. "Rarely" is not "never".

I actually agree with Dave that pre-paying your mortgage isn't the most financially savvy thing to do over the long term. But I think it's harder to convince people of that in a time of both declining house and stock prices.

Let's say you take Dave's advice and stop putting that extra money into your house, but instead start investing it in, let's say, a good stock index fund The stock market goes down for five years and lo and behold, you have to sell your house. Adding together your depleted investment fund and the (smaller) equity you have in your house is never going to add up to as much as you would have if you continued to prepay your mortgage.

An even worse scenario is if the value of your house also declines in that five years, and who knows at this point whether that might not happen? Once again, adding your depleted investment fund together with the smaller equity in your house is going to result in less funds available to pay off your mortgage than if you'd continued to prepay. You seem to think that one somehow cancels out the other.

As I said, if there are sufficiently safe and sufficiently liquid investments available right now at high enough rates to cover the tax-adjusted costs of a mortgage for the average homeowner, I'd sure like to know about them.

"But that is exactly what you are doing by paying off your mortgage. Home equity *is* an investment, and Don's point is that it can be just as risky as other investments. "

Except that I live in my home, something that I can't in my stocks (or other investments).
I don't care, if my home value falls 50% because I won't sell anyways.

However, if my other investments fall drastically (which happens. just read today's news) and I didn't pay off my mortgage and lose my job, I would feel like a real idiot.

"Except that I live in my home, something that I can't in my stocks (or other investments)."

You receive the shelter value of your house whether it is mortgaged or not. Moot point.

"I don't care, if my home value falls 50% because I won't sell anyways."

Sometimes there's no choice. You could lose your house under Emminent Domain, possibly even at the new 50% value if it had already fallen that far.

"However, if my other investments fall drastically"

If that is even a possibility you chose investments that were by far too aggressive, which is also an idiot move.

"and I didn't pay off my mortgage and lose my job,"

And as long as the remaining value of the liquid investments is enough to cover mortgage payments until you get work again you'd make it. And paying off the mortgage isn't even the option for most people anyway - a more common scenario is what to do with an extra $10K or $20K - pre-pay a mortgage balance of $200K, or invest it? If you still have any mortgage balance, then you have monthly payments due.

Hi Harriethomeowner,

(After 10 years, we would owe $323k on the house and would have $562k in cash. And so on.)
So it seems that one WOULD come out ahead ... or at least would have plenty of cash on hand if needed.
Is that what you're saying, Don, or am I misunderstanding or oversimplifying?

You are definitely getting the concept... although (for understanding purposes) you're perhaps oversimplifying a bit... or more accurately over-assuming certain givens. HOWEVER the principal is clear, and you are understanding that principal accurately.

=================================================

Hi pkguy,

No more debt. I love the peace of mind it brings, being able to pull up into my driveway and know that I own my house lock stock and barrel.

This is an emotionally-based decision, which cannot be judged as "wrong" by anyone not in your shoes.

Financially, as long as you are in the position where your future security and lifestyle will not suffer by the loss of the home, or the loss of the value of the home, then you ought to be fine.

=================================================

Hi jrldh,

The way things are going with the financial markets at the moment just doesn't make me confident in investing money.

This is an emotionally-based decision, which cannot be judged as "wrong" by anyone not in your shoes.

Financially, as long as you are in the position where your future security and lifestyle will not suffer by the loss of the home, or the loss of the value of the home, then you ought to be fine.

If find it irresponsible to paint a picture where paying off debt that is secured by collateral that, if gone, would severely disrupt one's life, is a bad choice in an environment where popular investment vehicles are dropping off a cliff, so to speak. Don, are you stuck in the late 90s or what?

HARDLY! LOL!

Nobody's been accusing my equity-diversification suggestions as being "popular investment vehicles" here... ;~)

I stand by my position;
Depleting your cash to remove your protective leverage (that can otherwise be offset by growth accounts) prior to being able to afford the losses of liquidity is a financially foolish gamble that you'll never be in the position needing that liquidity.

=================================================

Hi SubMD,

At a time when 30-year fixed-rate mortgages are 6%, where would you find a *safe* investment paying 8% for 30 years?

As just ONE example, at least one Indexed Universal Life contract I am familiar with offered by Old Mutual has averaged 9.7% annual credits, net of the required life coverage premium deducted, and GUARANTEES not only never a loss of principal, but a positive 1% minimum if the index is anything less than 1% (including net loss years in the stock markets.)

That's just one hard example... there are others, but the return is the least of importance over conservation of overall net worth and liquidity.

=================================================

Hi pkguy,

How does this "don't pay off mortgage" relate or compare to todays questionable job security versus the "old days" of around say 15-20 years ago where many people went to work for a company and stayed with it until retirement. Didn't matter whether they were an on the floor factory worker or someone in the office. That type of employment seems to be going the way of the do-do bird.

The issue is NOT "don't pay off your mortgage" but rather to accumulate your security SEPERATED from your real estate until you can SAFELY afford the risks of eliminating the mortgage.

A very significant diference.

It is AS MUCH or even MORE appropriate NOW that boomers are living longer, and need the extended security of a real cash position... and ESPECIALLY since retirement cashflow is now the boomer's defined-contribution responsibility, rather than the defined-benefit pensions of the past (or did I flipflop the descriptions? I'm on the fly here... so please adjust, I trust you understand the point.)

=================================================

Hi jrldh,

I also find it a peculiar time for Dave to be flogging this particular horse considering what's going on with both the stock market and house prices.

RRRREEEEALLLYY!!?!??????????? When *IS* it most appropriate to talk about avoiding risks? AFTER the horses have left the barn?

If present trends continue for some time, then one could wind up with both a big loss in the investment portfolio and a house that's worth less than the mortgage balance.

ONLY if you're taking safety equity and throwing it into loss-vulnerable securities.

Add to that a move forced by job relocation or loss, etc, and you're looking at financial disaster.

ALL the more reason to be liquid seperate from your real estate. Lose your job, and you wont' even QUALIFY for another mortgage, let alone be able to afford the transaction costs and turntimes.

=================================================

MFBenson,

I started out in this thread by arguing with Dave, now here I am sticking up for him...

It is REALLY encouraging to see "the light go on!" Your understanding is becoming solid, as evidenced by your responses in this thread.

=================================================

HERE'S THE THING;

It *IS* possible to guarantee zero equity loss with certain indexed growth accounts (in universal life (tax-free,) indexed annuities (tax-deferred,) or exchange-traded structured notes (taxable.)

Each of these ALSO offer varying degrees of upside, varying side-benefits, and varying cost structures.

SEVERAL easily outperform after-tax mortgage costs on a mid-to-long range average basis.

Those that do not outperform, but under-perform on average can be looked at as the cost of conservative security... the "insurance premium against losing money."

Some people (almost like a religion) are against risk management via insurance or pooled-risk avoidance structures. You can't teach something to somebody who has no willingness to learn.

For those that DO wish to learn, read carefully, eat the meat and toss away the bones.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner

Thank you to Dave and anyone else here who has contributed good info to this thread.

American are not accustomed to talking about personal money openly. Even among family and close friends. I hope younger people will become more educated about finances.

"You receive the shelter value of your house whether it is mortgaged or not. Moot point."

Not a moot point. You don't understand, apparently.
If it is mortgaged and I can't pay the mortgage anymore I lose my shelter.
If I don't have a mortgage but own the house, this problem simply doesn't exist. So it is by far not a moot point. To the contrary, it is the essence of the "safety" vs. "investment" argument.

And no, obscure things like foreclosure because of property tax delinquencies and eminent domain don't count much. Because what's the chance of that happening.

Thanks Dave..
I think defined benefits (pensions) are pretty fast disappearing in favor of the defined contributions since the expectations are that lifetime employment with one company is fast disappearing as well. At my employer, since retired now, we had to make a decision about 8 years ago which of the two we wanted our pensions allotted. I went with DB being so close to the finish line.

SubMD asked "At a time when 30-year fixed-rate mortgages are 6%, where would you find a *safe* investment paying 8% for 30 years?"

and Dave answered:

As just ONE example, at least one Indexed Universal Life contract I am familiar with offered by Old Mutual has averaged 9.7% annual credits, net of the required life coverage premium deducted, and GUARANTEES not only never a loss of principal, but a positive 1% minimum if the index is anything less than 1% (including net loss years in the stock markets.)""

While it's true that Old Mutual is allowed to advertise that its MasterChoice insurance product has averaged 9.7% annual credits, it should be noted the 9.7% is averaged over the 25-year period between 1982 and 2006, whereas MasterChoice was introduced to the market in Oct of '03. The credits are indexed to the S&P 500 and reflect that index's ups and downs. For the same time '82-'06 time period, the S&P index's average rate of return with dividends was 13.25%.

On the downside, a MasterChoice policy holder would have received only the minimum 1.00% credits in six of those 25 years and would have received less than 2% in 2007. The returns are capped on the topside. That means that no matter how well the S%P preforms in a great year, your credits are topped at 15% -- the cap used to be 17%, but Old Mutual cut that back to 15% in April of last year.

The MasterChoice policy isn't as risky an investment as an S&P index fund. It also won't make you nearly as much money over the long term. That makes sense because, as most people know, investments that have the promise of greater returns carry more risk.

But no one should think that MasterChoice or and other insurance policy that's tied to a stock market index is risk free. It does NOT represent a "safe" investment in the sense that most people understand it. Yes, it's true that your principal will return 1% in a bad year. But 1% is a whole lot less than the tax-adjusted interest rate of your mortgage. And that's what MasterChoice would have returned to its policy holders for three years in 2001-2003 had in been in existence. During the period 2001-2007, its average yearly credit would have been about 5.9%. But don't forget that the compounded rate of return would be about 1% lower, or 4.9% and we have to use the compounded rate because that's how your mortgage interest is calculated. From that, you have to subtract the cost of the premium. And there's going to be a surrender charge i you cancel the policy before it matures and the extra costs of any riders you purchase and so on.

Now to be fair, it's an insurance policy and you do get a death benefit. Part of the premium pays for this feature and that's why the rate of return is lower than the index it's based on.

The bottom line is that a product like this carries much more short-term risk than "safe" investments like CDs, money market funds and Treasury bonds. Long term it will almost certainly make you more money than any of those investments, but not nearly as much as if you'd invested in a good index fund and bought cheap term life insurance instead.

It's up to everyone to decide how much they want to leverage their mortgage investment and how much risk they're comfortable with. But make sure you understand what the actual risk is of any investment vehicle you're thinking of buying, Above all, don't take the agent's words at face value because, as we all know, s/he's not an objective source of information.

"If it is mortgaged and I can't pay the mortgage anymore I lose my shelter. "

The only way that could happen is if you lose your income and *all* of the money in your savings and other investments. If money becomes *that* tight, you aren't going to be able to pay the property tax bill or the utility bills, and you'd lose the house anyway.

"tax delinquencies and eminent domain don't count much. Because what's the chance of that happening."

Its a lot higher than the odds of the value of a universal life policy or a tax-favored annuity going to zero.

Paying off a mortgage early is not necessarily a bad move, its just that there are generally better places to put the money first.

Hi FF,

Nicely explained on the OM MasterChoice program. The individual yearly returns are meaningless (versus individual yearly mortgage costs) as long as we are talking about longterm strategies, and the safe returns on the leverage.

Guarantees against losses on the downside are matched by maximum credit levels at the topside, naturally.

However,
The bottom line is that a product like this carries much more short-term risk than "safe" investments like CDs, money market funds and Treasury bonds.

This ignores TAX risks, and INFLATION risks, which as any retiree will explain to you, becomes evermore burdonsome when your work-a-day career-life is drawing near the golden years.

If you have some religious problem with the growth aspects of Indexed Universal Life, and buy into the securities-salespeople's fear hoopla about Fixed & Indexed Annuities, your NEXT best "safe" vehicle would be the taxable exchange-traded structured Notes you can get from several large Wall Street houses.

VERY LASTLY... if you find yourself in no option but a fully-taxable, non-compounding CD, at least go with a structured Indexed CD, and get the upside credit benefits matched to the large-scale securities markets while eating the internal costs of the government depository insurance.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner

Thanks for your kind comment, Dave.

Actually, we intend to put some of our money into annuities when the time comes, which won't be too long. I'm certainly willing to trade some return for security in retirement. We'll still keep some funds in the markets and have a certain segment in money markets, CDs or the like.

As for ETNs, I understand the IRS has yet to rule on their tax treatment. I wouldn't take a serious position in them at this point because the risk of a big hit should the ruling be unfavorable is too great.

No matter how you slice it, it still comes out the same way. You can diversify your own investments, you can hire an FP to do it, or you can purchased hybrid products like yours, but you're always going to be in the position of balancing risk against return, inflation ans taxes notwithstanding. That's just the nature of the investment animal.

Insurance companies have long been packaging up term insurance in combination with investments. First (at least as far as I know) there was "whole life." Then "universal life" became popular. Now, we see even further hybridized products like "equity indexed universal life" policies.

They are always sold as "safe" investments that will give you a good rate of return. They're structured so that most people don't understand how they work. They carry high premiums, which lowers your net return. They have agents who make good commissions when they sell them.

What they DON'T do is change the risk/return balance. Equity index policies aren't as safe as regular universal life, as one would expect because they carry a higher rate of return. For the same level of return they are not any "safer" than structuring your portfolio yourself or paying a professional to do it for you if you don't feel up to the job.

That's why they don't interest me. But I'm sure they suit some people, and that's fine as long as policyholders understand the balance between risk and return in the product they've bought.

Interesting times to revisit this question:

Two years ago I paid off my mortgage. $160k - modest but typical for DFW.
House is worth $205k (was $200k when I bought - no bubble here)

Let's compare:

Scenario 1: Had I kept my mortgage and invested with a return that tracks the DJI:

Had I invested my $160k, this would now be worth $141.5k. In the 24 months, I'd paid $23k PI on my 6% mortgage:
$141.5k
-$23k
-----------
= $118.5k

So my $160k shrank to $118.5k

Today the house is worth $205k. The balance on the loan would be $156k, which results in an equity of:

$205k
-$156k
-----------
= $49k

So the $160k + house turned into $118.5k + $49k = $167.5k

But I paid off the mortgage two years ago. That saved me 24 PI payments, totalling $23k. The house is worth $205k.

So the $160k + house turned into $23k + $205k = $228k

Which means paying off the mortgage was $60.5k better! Even with tax benefits, which at a max were $7k over two years, it is still $53k better!

Bonus: I don't lose sleep over what's going on at Wallstreet this week!

jrldh,

Paying off early didn't save you 24 PI payments. It only saved you the I (interest). You just paid the P (principle) sooner than you needed to.

However, I envy you that paid-off state of mind.

I love not having a mortgage. Many people don't get any tax saving from interest payments. There is wonderful peace of mind having a paid for house, too. My total house outlay is $300 a month for taxes and insurance.

Hi jrldh,

Congrats on your feelings of safety and good sleep! You are certainly fortunate that your real estate equity has not yet been under pressure like so many others, and that's a blessing to appreciate!

Of course, as with ANY 'naked asset' that you own in full exposure "past performance is no guarantee of future results." Your unleveraged equity is now at full exposure to not just the market, but potentially all other uninsured risk elements as well. These are what are known as S.L.A.P. risks;
Softening market values,
Litigation exposure,
Acts of God (and we've certainly seen these recently,)
Personal catastrophe (inlaws, exes, and/or medical economic disasters.)

You look at "Scenario 1" as shifting your at-risk real estate equity into at-risk securities equity (DJI.)
This wouldn't have been a very well planned equity re-employment, as you would have simply traded full expore risks in real estate assets into full exposure risks in the stock markets.

Let's look at a better "Scenario 2";
You had shifted your $160,000 into an S&P-indexed tax-free universal life account which offers dollar-for-dollar upside when the stock move up, "catches" any upsides as a "high water mark" on an annual basis, and keeps a "no loss guarantee" floor so that if/when the stock markets drop your equity doesn't lose a dime.

These cash accumulation accounts are averaging 9.6% annual positive credits because of their "upward ratcheting" design, and the average annual cost over their account life is about 1% of balance, so your average net annual "return" is 8%-ish... however, that 8% return is income tax free, as well as being sheltered from the financial industry and real estate market storms.

Your $160,000 leverage cost you a rate of 6% pre-tax, and (assuming an 18% marginal tax bracket) 4.9% after tax (6% multiplied by (1.0 - 0.18)). That $160,000, more safely employed, would have earned you a pre-tax rate of 8%, which is the taxable equivalent of 9.8%, using the same marginal income tax bracket assumptions (8% divided by (1.0 - 0.18%)).

Your 2 year equity balance would have been;
Yr 1: $160,000 * 1.08% = $172,800
Yr 2: $172,800 * 1.08% = $186,624
TOTAL GAIN = $26,624

Your 2 year after-tax cost of leverage would have been;
Yr 1: $160,000 * 0.049% = $7,840
Yr 2: $160,000 * 0.049% = $7,840
TOTAL COST = $15,680

NET 2 YEAR GAIN, TAX FREE = $10,944

For many folks, this is a NICE retirement supplement, and knowing that their equity is finally protected from market and "SLAP" risks help them sleep far better at night as well.

FURTHER, since the gains are income tax free, they do NOT trigger taxation on Social Security income (as do distributions from qualified tax-deferred accounts like IRAs, 401(k), and 403(b)s...)

SO... what you don't know CAN cost you... and what you DO know can protect (and even grow) your financial freedom.

Cheers,
Dave Donhoff
Leverage Planner

Are you talking about life insurance like mentioned in the link below?

Phew, good that the socialist government of the USA bails out insurers like AIG then!!

Here is a link that might be useful: Equity Index

Hi jrldh,

No, you linked to an article about a salesman pushing indexed annuities with longterm maturities (longer than 7 years) to 90 year old seniors.

Accumulation accounts in universal life contracts are markedly different.

A) You're not even ALLOWED to bury the full amount of the planned account value into it all at once, the maximum you can contribute is a but over 20% of your desired amount per year... so it is impossible for anyone to get "fast-pitched" into it (which explains why the stock jockeys hate it and the annuity hustlers avoid it, leaving pretty much only Financial Planners who operate for the long run of their clients,)

B) 100% of any pre-deposited cash values above the basic insurance premium is fully withdrawable WITHOUT any surrender penalty... so a client using an indexed universal life contract account would never face the nightmare the senior got in that article you brought,

C) Cash-value life accumulation contracts differ from annuities in FIFO tax treatment, as opposed to LIFO for annuities. This means that the already-taxed original-deposit principal funds (the money that went "first in") can be considered "first money out" whenever drawn, so that the client will have access to them tax free (since they had already been taxed before deposit,)

D) Universal Life accumulation accounts allow for zero interest rate loans of the growth (profits) credited to the life account... and that means that after a client has eventually drawn down the original deposits that they had employed into the account over the years, they can simply "borrow" the remaining profits from themselves at no interest costs, and no income tax burden... rather than "withdrawing" the funds and having to pay income taxes on them. The "loan to self" never has to be repaid until the account owner passes, and the coverage pays the difference to the owner's estate,

E) Because the owner gets access to their spendable living cash tax free, it also DOES NOT trigger the income tax burdens on their social security benefits.

AND... to top it all off (sure to make you smile,) NONE of this is emburdoned to the taxpayer through Uncle Sugar! No socialism mandate, no government corruption, no "class warfare," and no indebting of our grandchildren's grandchildren at all!

Cheers,
Dave Donhoff
Leverage Planner

So Dave, how common is it, really, for people who are appropriate insured (title, homeowners, umbrella) to actually lose large amounts or all of their equity?

In theory, DH and I lost equity when the bubble burst and the inflated market value of our home dropped about $40K to a more reasonable level. But that reasonable level is still more than twice our purchase price.

We've seen comparable drops in our 401k accounts, which are diversified across many mutual funds. Those are not immune either. And safer investment vehicles generally have lower returns. (And yes, we have them, too, plus a one-year emergency fund).

We are quite happy to be in year 4 of a 15-year refi with a mortgsge principal less than my salary.

Hi Mary,

So Dave, how common is it, really, for people who are appropriate insured (title, homeowners, umbrella) to actually lose large amounts or all of their equity?

Its difficult if not impossible to insure against EVERY risk with traditional insurance products (including umbrella coverage policies.) I suppose that if we *ONLY* look at the few folks who get extensive coverage for legal risks from within the family, and sufficient disability risks for ALL family members (so that a loved one's required attention by an otherwise insured principal earner doesn't also enburdon the family's income requirements,) then I would imagine that the downsides are fairly low.

How common is it, really, for people to take on THAT much coverage, and cross-coverage, when "everyone seems healthy" and nothing appears to be at risk, on the surface? (Answer; extremely uncommon.)

In theory, DH and I lost equity when the bubble burst and the inflated market value of our home dropped about $40K to a more reasonable level. But that reasonable level is still more than twice our purchase price.

How much had you lost by not only not having that $40,000 protected, but also not having it growing for your retirement safety? IOW, the opportunity costs you paid for that "peace of mind" and letting the drawdown happen unaccounted for?

We've seen comparable drops in our 401k accounts, which are diversified across many mutual funds. Those are not immune either. And safer investment vehicles generally have lower returns. (And yes, we have them, too, plus a one-year emergency fund).

Good. Everybody is wise to determine how much of their net worth they are comfortable having at risk of loss, and putting that much into aggressive "investments" that can actually lose money... and putting the amount they cannot afford to lose into more conservative principal-protected growth accounts for safety & security.

OH, and by the way... when the "investment" accounts with the unlimited upsides are taking it in the shorts, like they are today... suddenly the "boring 5%-8% principal guaranteed" accounts seem not so terrible, no?

When all the equities are in the red, and you just want to no longer lose money because you don't have enough earning years left... "zero is your hero!"

We are quite happy to be in year 4 of a 15-year refi with a mortgsge principal less than my salary.

Congrats on your happiness! Again, if that's a risk you're comfortable with here's hoping the equity risks payoff nicely for you in the end with no surprises!

Cheers,
Dave Donhoff
Leverage Planner

But Dave, again, I ask how common is it for people to really lose most or all of their equity? Sure, it's uncommong for people to have coverage against every possible risk. But how often to they really suffer a loss due to a lack of that much coverage? How often do they really lose their equity other than due to market fluctuation?

Hi Mary,

But Dave, again, I ask how common is it for people to really lose most or all of their equity?

Stop and think about that for a second... and think about the number of homes that are wiped off the face of the Earth each year simply by natural disasters.

What portion of those lose most, or all, of their real estate equity? I don't have the statistics, but its quite significant to say the least.

The Southern states with the hurricanes are simply the most obvious recently, but aren't the only areas vulnerable to uninsured (and uninsurable) losses from plain ol' natural disasters....

And natural disasters are simply the EASIEST to understand & identify with. In reality the other SLAP risks are just as prevalent and damaging to equity values.

Sure, it's uncommong for people to have coverage against every possible risk. But how often to they really suffer a loss due to a lack of that much coverage?

How often???? It only takes once!

How often do they really lose their equity other than due to market fluctuation?

Market fluctuations are never permanent... people only really lose their equity value from market drops when they are also trapped due to unforeseen timing or poor planning into selling before the inevitable recovery.

I would venture that the MAJORITY of permanent equity loss, other than sales timing entrapment during a down cycle, comes from uninsured health-related and economic/employment issues that could have been avoided with greater liquidity and seperation of equity from the real estate itself.

CHeers,
Dave Donhoff
Leverage Planner

Dave -
Aren't you a mortgage broker?

You know, I am a regular on a couple of the other boards on this site, but not here. Although I like to lurk on this board, I grow weary of it often because of this constant push. Dave's constant single-issue posts are a bit off-putting to me. If diversification is the goal, then how about spreading your wings a bit, my man?

But seriously, I understand the problem of retirees being house-wealthy and cash poor. But there is a balance to be had that can include investments AND a paid-off home. First, a move to a geographical area with lower property costs and tax burdens and the (usually) associated much lesser volatility in the housing market. Second, adequate long-term care insurance and term life to protect the remaining spouse's financial security. Third, a reasonably priced home so that investment and morgtgage paydown is simultaneously achievable. These are simple things that can be done and that don't require "leveraging" one's retirement shelter.

I understand the math. I get it. I really do. But keep in mind that some people consider their homes dwellings rather than investments to be leveraged.

You are dismissive of the decision to pay off a home early as being an "emotional" personal decision. But isn't any "investing" of any kind emotional and personal to a degree? Of course it is. Different individuals have different risk tolerances, different goals, different time lines. Investing is not one size fits all. Unfortunately your advice is.

I think I was particularly troubled by your assessment that most folks are not adequately insured for all potential risk. Your solution for these folks who are unsophisticated in the ways of risk assessment? Don't pay off your house and trust the market and annuities.

I, for one, never underestimate the value of unencumbered shelter.

Jakabedy
Security Planner

I have an interest only loan that is 10x higher than my initial mortgage was 30 years ago & I'm within one year of retirement. There were reasons for it, purchase of other property that I paid cash for & the expectation of receiving an inheritance from my parent's estate to use to pay off my mortgage. Parent's property did not sell & I am left holding a loan with considerable interest.

Both my husband & I work with good salaries, however, I take sole responsibility for my financial future and do not consider his income. Now, I am making very hefty payments on the principle to shrink the interest payments to a level I feel comfortable with. Payroll deductions for thrift contributions (currently 9%), Series I savings bonds and other savings should prove relatively safe. 6 months ago I switched my work thrift from stocks to bonds and also withdrew some major cash to purchase raw land. That land will be placed in a state stewardship program to cut the tax burden and provide an inheritance for my sons.

Financial security is highly personal-unless there is enough discipline to button down expenses/and or increase income in time of economic pressure, risk should not be assumed. I find it highly ironic that so many people are in extreme circumstances today in spite of what all the experts say. So, pre-pay a mortgage? If it means more cash flow without increased risk and a better standard of living, why not?

Hi Gardenspice,

Aren't you a mortgage broker?

We are licensed to originate mortgage loans as a brokerage, among other financial licenses, yes.

======================

Jakabedy,

You are opinionated, and everyone deserves their chance to expresse their opinion...
HOWEVER,
Have you bothered to actually sit down and READ my posts? (It certainly doesn't not appear that you have.)

I am CONSTANTLY talking about diversification....
My posts are virtually NEVER "single issue"...

I've NEVER been "dismissive" of anyone making emotional decisions, AS LONG AS THEY DON'T DECEIVE THEMSELVES WITH JUSTIFICATION THAT THEY ARE OBJECTIVE, FINANCIALLY CONSERVATIVE DECISIONS (seriously... have you decided to respond without reading ANY of what I actually write???)

You were "particularly troubled" by my pointing out most folks are underinsured... then you PROJECT solutions upon ME that I have never espoused!

STOP STOP STOP!!! Go back and R-E-A-D!

(I'm always fascinated by the oh-s0-righteous who take ME to task... and go ricocheting off into the ethosphere at angles nobody could have ever imagined....

Reminds me of the old SNL skit with Gilda Radner... going off about "Violins in Isreal"... LOL!!!)

========================

Hi Mulchmamma,

So, pre-pay a mortgage? If it means more cash flow without increased risk and a better standard of living, why not?

EXACTLY right!!!! Its simply sad and amazing that so few people stop to actually "do the math" and determine WHEN it is finally appropriate to eliminate the leverage, and all it provides.

Have an awesome weekend!
Cheers,
Dave Donhoff
Leverage Planner

"AND... to top it all off (sure to make you smile,) NONE of this is emburdoned to the taxpayer through Uncle Sugar! "

Is this a benefit or a disadvantage?

Because if I had put my life savings in a life insurance policy that I cannot access for many years without penalty, I'd have sleepless nights reading how banks fail, insurance companies are at the brink of failure etc.

This investment vehicle that you suggest isn't even FDIC insured! So if this life insurance you pitch actually does fail (quite likely, if you read the news nowadays), I'd have NOTHING. ZIP. NADA. - except my mortgage on my house.

As it is, I have plenty of CASH (oh, the horror), own my house free and clear, have no debt and if I should lose my job (a real possibility, given how things are going), I am soooo glad, I am not indebted to anyone and will be able to live in my house without the risk of eviction for several years just on savings alone (btw. I'm in my mid 30s and really glad I didn't fall for this leverage nonsense - judging by the pale looks in the panicked faces of my coworkers who don't own anything besides investment "papers" that fall 10% each day).

>>think about the number of homes that are wiped off the face of the Earth each year simply by natural disasters. What portion of those lose most, or all, of their real estate equity? I don't have the statistics, but its quite significant to say the least. It would only be true if they had no homeowners insurance or the insurance, for whatever reason/Acts of God, did not pay out.

Homeowners whose properties were damaged in the 1989 Loma Prieta earthquake, centered in Santa Cruz, all rebuilt or sold their properties, in which case the new homeowners rebuilt. Current price for a 2bd house recently sold was reported on Zillow as $799K. I can assure you that in 1989 that home would not have cost more than $200K, and most probably less than that. Our 2 bd Oakland hills home was purchased for $180K in 1989 at the very top of the market, just before values fell (lucky us, LOL).

Insurance does not pay everything, but the value of the property is in the land. Out here some 75-80% of the value is land-only, which is why there are so many tear-downs in older neighborhoods like ours.

During the 1991 Oakland hills firestorm, many homes were completely destroyed. All of them were rebuilt (and most of them a lot larger than before, not surprisingly). One of our friends had been burned out for the SECOND time - they lost their first house in the 1982 hills' fires! Each time they said they had to come up with about 15-20% to rebuild the house to equal their previous dwelling. Despite their being burned out twice, they had received such considerable appreciation between the two fires, in the end they said they had not really lost any money.

Lots that were not immediately rebuilt, were sold to other owners who would rebuild. They just aren't making any more land around the SF Bay Area [grin], so buildable lots are always valuable.

So I don't agree with you that considerable equity is lost. In an earthquake or fire, I would expect to have to come up 15-25% to rebuild to our satisfaction, but the remainder would be covered by our homeowners and earthquake insurance policies.

Hi jrldh,

if I had put my life savings in a life insurance policy that I cannot access for many years without penalty, I'd have sleepless nights reading how banks fail, insurance companies are at the brink of failure etc.

So then only use cash-value accounts where you are NOT restricted from accessing all, or the majority, of your cash value,

This investment vehicle that you suggest isn't even FDIC insured!

To quote you;
Is this a benefit or a disadvantage?

Life policies are insured for much more than the $100,000 minimum the FDIC policy covers (often 5 times the FDIC limits) and have the identical perfect record (nobody in the U.S. has lost their cash-value principal from a life insurance company failure in the history of the industry.)

So... which "insurance policy" would provide sounder sleep when talking about life savings protections?

So if this life insurance you pitch actually does fail (quite likely, if you read the news nowadays), I'd have NOTHING. ZIP. NADA. - except my mortgage on my house.

Wrong, entirely. See above.

As it is, I have plenty of CASH (oh, the horror), own my house free and clear, have no debt and if I should lose my job (a real possibility, given how things are going), I am soooo glad, I am not indebted to anyone and will be able to live in my house without the risk of eviction for several years just on savings alone (btw. I'm in my mid 30s and really glad I didn't fall for this leverage nonsense - judging by the pale looks in the panicked faces of my coworkers who don't own anything besides investment "papers" that fall 10% each day).

Depending on how you define "Plenty of cash" that is the key to it all... and perfectly in alignment with everything I advise from the top down.

You'd have to squint and ignore my content really hard not to have realized that by now. Cash is king... and giving it up to eliminate beneficial leverage before you can actually afford to is simply dangerous to your financial safety. That's all there really is to it.

=============================================

Hi Jkom,

You're right in regards to equity... but you missed the point about liquidity (which I may have been lax in specifying above.)

If you have a "free & clear" home that is well insured, and it is wiped out by a combination of cross-insured events (like hurricane victims who were cross-covered by flood insurance and also wind/rain damage insurance... who then fought amongst each other in courts all the while holding back your home value benefits...)

VERSUS... the neighbor with all (or most) of their home equity seperated into a principal-guaranteed growth savings account...

The person with their equity rebalanced into safer non-vulnerable accounts is clearly in a far better position for their immediate family's security and their life continuity.

Cheers,
Dave Donhoff
Leverage Planner

I see this has risen up again. Gotta say I'm feeling mighty fine right now that I paid off my mortgage in 15 years rather than taking cash out and investing add'l funds in the market. Math may not add up in the long run and it may be "emotional" but it's a great feeling at the moment.

Hi Dave,

I admit I didn't read every post in this thread as so many started to seem repetitive.

But I do have one question anyway; if you've already adressed it above, please let me know and I'll go read more thoroughly.

Suppose you own a home, with a mortgage for most of the value of the home. And because you haven't prepaid the mortgage, you've saved quite a bit of money and invested it and it's doing ok and is safe. And you have the house insured, of course. But something, not covered by insurance, happens to the house, destroying it. This, I think, is one of the reasons you say it is good to have the mortgage and the savings elsewhere. Am I right or mistaken about this?
If I am right, then my question is - don't you still have to make your mortgage payments until the mortgage is paid off? And if so, are you really that much better off? I guess I can see that you would be. If you had $100K in savings and only had to make a $2K a month payment on the mortgage on the destroyed house, then you'd be able to continue living (renting maybe) off your income, assumming you still had a job at the time (your place of business wasn't destroyed by the same event that destroyed the house). What are your thoughts on the various options here?

Hi Thetews,

Suppose you own a home, with a mortgage for most of the value of the home. And because you haven't prepaid the mortgage, you've saved quite a bit of money and invested it and it's doing ok and is safe. And you have the house insured, of course. But something, not covered by insurance, happens to the house, destroying it. This, I think, is one of the reasons you say it is good to have the mortgage and the savings elsewhere. Am I right or mistaken about this?

Yes, partially right anyways. The more important benefit is that you are left in full control and access of your equity value in immediately (or fairly rapidly) accessable funds.

Even when you are fully insured against the disaster that wipes out your home, getting access to your insurance benefits can take a long time (and sometimes involve legal processes in defense of your benefit demands.)

If I am right, then my question is - don't you still have to make your mortgage payments until the mortgage is paid off? And if so, are you really that much better off? I guess I can see that you would be. If you had $100K in savings and only had to make a $2K a month payment on the mortgage on the destroyed house, then you'd be able to continue living (renting maybe) off your income, assumming you still had a job at the time (your place of business wasn't destroyed by the same event that destroyed the house). What are your thoughts on the various options here?

You've thought through and self-answered your own question perfectly!

Cash is king... and when all else fails, you can survive through the tough spots on cash-in-hand... but "interest saved" by giving away that cash back as early payoffs to the mortgage bank (even if it emotionally felt great at the time) won't even buy your kids a sandwich when everything is unaccessible.

Cheers,
Dave Donhoff
Leverage Planner

I haven't read the whole thread. But--

Did anyone mention how suspicious it is that the Consumer Reports article compared paying down the mortgage to investing in the S&P 500 from *1986 to 1996*?!? Peculiar years to choose, don't you think? Instead of, say, the most recent ten years, which is what the Wall Street Journal called "The Lost Decade" back in March 2008, when Consumer Reports published this article? Nominal 10 year S&P returns are at negative 18% as of today!

Uh Humm, where is D.Donhoff, Fannie Mae & Freddie Mac now..2 of the 3 are under house arrest.

Hi Woodinvirginia,

Uh Humm, where is D.Donhoff, Fannie Mae & Freddie Mac now..2 of the 3 are under house arrest.

I'm right here, same as before... and the financial truth stands unchanged.

Thanks for asking!
Dave Donhoff
Leverage Planner

Dan:

I read from the very top of this thread when I stumbled upon it via a Google search on 'Prepay vs Refi'. Very emotionally charged this thread; must have spent a good 2-3 hours trying to understand the postings. I was totally against your argument (angry even) in the beginning but eventually came around to understanding what you are trying to explainthe basic economic concept of maximizing your utility.

We are currently in the 7th year of a 30-year fixed mortgage at 5.75%. Eventhough we could have originally afford a 15 year mortgage, we choose to have the Âleverage of lowered monthly payments so that we can 1) invest the additional money or 2) be financially stable should one of us looses a job. Through budget tightening, we now have an extra $400 a month to invest. I took about a 50% hit on my various investments last year (401k, VUL, IRA) and this quarter does not look to promising either so I am somewhat skeptical on when the market might rebound. With this skepticism in mind and the fact that I hate my mortgage company for what they did to us post-Hurricane Ike, we are thinking that the additional $400 monthly towards the mortgage might be a better way to go for now. We like to think of it as our very own personal refinancing plan. Same results but no ridiculous closing fees and the flexibility to resort back to a lowered payment should one of us looses a job. With interest rates so low, we even thought about refinancing the Âother way to get another 30-year mortgage at 4.50% but still adding all the extra money towards the principle. Fees and recouping time steered us away.

Questions for owning the house outright: Why is Âhouse rich, cash poor so bad? As long as you can pay for your property tax and minimal utilities, you still have a roof over you head right? Granted standards of living might be lowered, but it beats living in the streets. You can always sell it and rent an apartment. Likewise for the imminent domain argument; some kind of compensation will be available for you. As for Act of God, insurance should compensate; or worse case scenario, you can pitch a tent on YOUR land.

Questions for carrying a mortgage and leveraging for as long as possible: As Âmorally repugnant as a previous user put it, you still can walk away from your mortgage should you be upside down and keep all your liquidity, right? The only things you would loose are your equity and credit (and dignity). Just chalk up the interest as rent paid for your time at the house (OR you can try to take advantage of the current Administration bailout policies J LOL). Seriously, should you walk, can the bank go after your liquidity in this situation? IÂm not familiar with bankruptcy and foreclosure rules and their ramifications. I always thought that walking away is one of the Âleverage I have for a prolonged mortgage. Also, an assumption that I always have is that all debts under my name would go with me to the grave should I die and my wife gets to keep the liquidity. Am I correct or does my wife have to shoulder the financial burden (life insurance aside) eventhough her name is not on any of the debts?

Hi Tom,
(JUST jabbing ya! Everyone calls me Dan, Don... whatever... ;~)

I read from the very top of this thread when I stumbled upon it via a Google search on 'Prepay vs Refi'.

Google is sweet, no?

Very emotionally charged this thread; must have spent a good 2-3 hours trying to understand the postings. I was totally against your argument (angry even) in the beginning but eventually came around to understanding what you are trying to explainthe basic economic concept of maximizing your utility.

I *LOVE* seeing that kind of epiphany happening!!!

We are currently in the 7th year of a 30-year fixed mortgage at 5.75%.

Side Note; REALIZE that the year # is meaningless except for how it affects the weight of your amortization burdens. The further you go, the heavier the weight on your payments against your liquidity.

You can *ALWAYS* stroke a check, at any moment, to eliminate as much of your leverage as you can afford. Of course... trying to do so BEFORE you can actually aford it (like the people who constantly shave away their safety cash with extra monthly principal surrender payments) is simply dangerous & cash-foolish.

Even though we could have originally afford a 15 year mortgage, we choose to have the leverage of lowered monthly payments so that we can 1) invest the additional money or 2) be financially stable should one of us looses a job. Through budget tightening, we now have an extra $400 a month to invest.

That is both smart, and responsible!

I took about a 50% hit on my various investments last year (401k, VUL, IRA) and this quarter does not look to promising either so I am somewhat skeptical on when the market might rebound.

OUCH! I would strongly suggest getting OUT of investments that are still open to downside losses, if you cannot aford to lose your principal. Your 401(k)* and traditional IRA (especially after the market collapses) can be rolled on a tax-efficient basis into a ROTH IRA (or similar) and then engaged in fixed-indexed instruments (income or growth annuities) that catch any annual upsides to the stock markets, lock in the gains against any future losses, and guarantee your principal against any stock market downsides.

That VUL can be tax-free 1035 exchanged to a fixed-indexed universal contract that will provide the same (or better) upsides, with guarantees against any losses to the downsides.

NOW is DEFINITELY the time to stop the losses and get in a position to take advantage of volatility (riding the up-waves, and then locking int the gains with guarantees against downside losses on the down-waves.)

With this skepticism in mind and the fact that I hate my mortgage company for what they did to us post-Hurricane Ike, we are thinking that the additional $400 monthly towards the mortgage might be a better way to go for now. We like to think of it as our very own personal refinancing plan. Same results but no ridiculous closing fees and the flexibility to resort back to a lowered payment should one of us looses a job. With interest rates so low, we even thought about refinancing the other way to get another 30-year mortgage at 4.50% but still adding all the extra money towards the principle. Fees and recouping time steered us away.

I'd suggest you were either miscalculating, or analyzing from a misperception. Depending on the size of your home value, re-balancing your leverage from 5.75% to 5% or lower, and moving as much of your real estate equity OUT of the house and into tax-free principal-guaranteed growth vehicles with stock-index upside (at a 8-10% average) versus yoru tax-deductible sub-5% cost of leverage... its really far safer, conservative, and more responsible.

Questions for owning the house outright: Why is house rich, cash poor so bad?

Because "you can't eat real estate equity."

As long as you can pay for your property tax and minimal utilities, you still have a roof over you head right?

Doesn't really matter if you can't afford the rest of the common costs of survival during duress.

Granted standards of living might be lowered, but it beats living in the streets. You can always sell it and rent an apartment.

Hate to be an involuntary, desperate seller in the current real estate markets... and that's what you are suggesting as the "safety-upside" to your plan.

Likewise for the imminent domain argument; some kind of compensation will be available for you.

"Some kind" of compensation? Google "Kelo emminent domain" and see how reliable our government is in that regard. Do you really prefer to leave your family's financial security & safety in the hands of the courts? (And do you really think that in times of desperation you can wait it out & fund the litigation required?)

As for Act of God, insurance should compensate;

Tell that to the H. Katrina people... the ones who got stiffed while various insurance companies played games of "chicken" through the court systems to see whether the damages to be covered were caused by wind-driven rain, or wind-driven floods (yeah... like it mattered!) And the entire time NO checks were issued...

Tell that to the California earthquake victims who's homes were destroyed by the indirect consequences, and not by the earthquakes themselves.

Insurance is the "contractual rental of other people's safety reserves." It can never effectively cover the safety you can give yourself by using your OWN reserves instead of someone else's (at their own rules of engagement.)

or worse case scenario, you can pitch a tent on YOUR land.

And feed yourself with what? Using what sewage systems? Getting water, heat & power where?

Cash reserves means you can take your family to safety, WHEREVER that may actually be.

Questions for carrying a mortgage and leveraging for as long as possible: As morally repugnant as a previous user put it, you still can walk away from your mortgage should you be upside down and keep all your liquidity, right?

The answer is; It depends on your state's laws. Some states say purchase money loans are non-recourse, but refinance loans are not (i.e. California,) while other states say that purchase loans ARE recourse, and equity refinancing is not (i.e. Texas.) Homestead laws are various among different states as well.

CASH is the ultimate law... "the golden rule" remember.

The only things you would loose are your equity and credit (and dignity). Just chalk up the interest as rent paid for your time at the house (OR you can try to take advantage of the current Administration bailout policies J LOL). Seriously, should you walk, can the bank go after your liquidity in this situation? Im not familiar with bankruptcy and foreclosure rules and their ramifications. I always thought that walking away is one of the leverage I have for a prolonged mortgage.

See above.

Also, an assumption that I always have is that all debts under my name would go with me to the grave should I die and my wife gets to keep the liquidity. Am I correct or does my wife have to shoulder the financial burden (life insurance aside) eventhough her name is not on any of the debts?

It depends on how you have planned & structured your estate. NOT to be taken lightly... a seperate conversation than cash/liquidity... but super-critical nonetheless.

Cheers,
Dave Donhoff
Leverage Planner

Touché! LOL. Sorry about the name, Dave :-). Did I mention I've spent 2-3 hours reading this thread? Thanks for your thorough reply. I can be verbose (sometimes) and I really appreciate you taking time to answer some of my concerns. Hopefully, you can elaborate a little further on the points below.

[That VUL can be tax-free 1035 exchanged to a fixed-indexed universal contract that will provide the same (or better) upsides, with guarantees against any losses to the downsides.]

Since my 401k is with a previous employer, the VUL is where most of my investment monies go into on a monthly basis. Im not familiar with the fixed-indexed universal contract. What is it? Does it provide for the life insurance aspect? Any fees associated with the switch?

[I'd suggest you were either miscalculating, or analyzing from a misperception. Depending on the size of your home value, re-balancing your leverage from 5.75% to 5% or lower, and moving as much of your real estate equity OUT of the house and into tax-free principal-guaranteed growth vehicles with stock-index upside (at a 8-10% average) versus yoru tax-deductible sub-5% cost of leverage... its really far safer, conservative, and more responsible.]
So you are suggesting that I re-up with another 30-year fixed mortgage? I have about $12,000 in equity on the house. How would I remove that equity from the house OR did you mean equity going forward should I refinance? I believe the refinance rate quoted me is 4.375% with $6,500 closing. I hate closing costs and the fact I have to stay another 3 years in my house in order to recoup. I guess I could use the extra cash along with my $400 surplus each month to invest in tax-free principal-guaranteed growth vehicles. What are some examples?

[while other states say that purchase loans ARE recourse, and equity refinancing is not (i.e. Texas.)]

Okay if my screen name hasnt given me away, what does recourse mean for Texans? Not that I would just up and walk out of the mortgage, but if real estate prices continue to tumble and I become upside-down, can I walk? Should I walk? Can I keep the cash I have in these other liquid investments? Or will the mortgage company try to go after them?

Ps. I was being facetious with the roof-over-you-head-at-all-cost questions :-b Just wanted to stir the pot a little since its been closed to a year now since the thread started.

Hi Tony,

Since my 401k is with a previous employer,

If you're no longer employed where that 401(k) had been provided, you are allowed to roll it out to an IRA. FURTHER, if your holdings have taken a hit to value, you may be able to use the carried-forward loss to cancel out the taxation of rolling straight out to a ROTH IRA (which is preferrable if you prefer to have it grow tax free rather than tax-deferred.) This is *NOT* a DIY thing though... you need a knowledgable financial planner &/or IRA specialist to handle this in a way you don't accidentally incur IRS penalties on yourself.

Since my 401k is with a previous employer, the VUL is where most of my investment monies go into on a monthly basis. Im not familiar with the fixed-indexed universal contract. What is it?

The financial growth accounts in the insurance world come in two categories; Fixed and Variable. However, UNLIKE mortgages... the terms are NOT self-explanatory.

In the insurance world, these are defined as follows;

Variable = earns money by being completely integrated with the stock and mutual fund markets, with full exposure to all the potential upsides, and full exposures to all potential losses. Further, because "variable" programs involve the trading of stocks/mutual funds directly in your seperate account, there are usually significant "management fees" charged to pay for the stock market jockeys who try to beat the markets.

Fixed = earns money by an "assigned credit" just as a CD or savings account at a bank would be. Fixed accounts can (and do) provide written guarantees of principal... a protection against any loss of money... fully backed by all the reserves held by that company.

Within the "Fixed" side of the insurance world, there are "Indexed" accounts. These accounts come with a guarantee protecting against loss of money on the downside, however the "credit" that is applied as your earnings is determined by tracking the rate of growth of one of the broad market indexes. The most common is the S&P 500, but the DOW, the NASDAQ, and the Russell5000 are also often available as a selection.

Fixed-Indexed accounts have no "management fees" the way that Variable accounts do. Instead, the provider offers a guarantee of no loss (so, no return less than zero,) and also puts a "cap" on the possible upside (i.e. if the index goes up 20%, and the cap is 15%, you are credited only as high as the 15% cap.) Due to the market positions taken, the insurance company itself probably only sees a return of maybe 17% as their own "cap" even when the market goes to the moon... but that 2% "haircut" is one ofthe ways they "make" their management fees, over time.

Does it provide for the life insurance aspect?

There are fixed-index annuities (appropriate for your rollout from the 401(k) to a ROTH IRA, for example.) These annuities have built in insurance features, but the benefit dollar amounts are generally just the balance of the funds put into the account.

There are also fixed-index universal life policies (the perfect replacement for the VUL accounts.) These can be structured with as little as $50,000 in death benefit, up to as high as your personal situation qualifies for (in some cases many millions of dollars in death benefits.)

Any fees associated with the switch?

There are two ways to go about using such program strategies;

A) No Load products... which have no internal "loads" or administrative fees & commissions. Of course, there is no free lunch unfortunately, and no-load products are only available through fee-only planners (so there you have fairly significant up front fees associated.)

B) Traditional products (or "normal load" though nobody calls them that.) Traditional universal life (and/or any other traditional insurance products) have ZERO up front fees to the client... but instead have either annual administrative fees, and/or a "surrender period" (similar to a prepay restriction for mortgages) during which you agree to leave your funds alone so that the company can have them make enough for BOTH of you so that the company's portion of the profits cover the transaction costs they paid to get it all set up in the first place.

So you are suggesting that I re-up with another 30-year fixed mortgage?

The answer is a big pregnant "maybe."

I have about $12,000 in equity on the house. How would I remove that equity from the house

Being that you are in Texas, you might not be allowed to, even if you wanted to. Texan legislators determined that Texans are not to be trusted with the final 20% of the equity in their primary residence (their homestead,) and wrote an ironclad restriction into the Texas Constitution itself prohibiting Texans from doing so.

OR did you mean equity going forward should I refinance? I believe the refinance rate quoted me is 4.375% with $6,500 closing. I hate closing costs and the fact I have to stay another 3 years in my house in order to recoup.

If you're not 90% confident, or better, that you'll have no reason to again refinance (let alone actually sell your home) for 3-5 years... you're likely better off leaving everything alone anyway.

The most prudent financial structuring (leverage versus asset classes) should always be done for a 5+ year perspective, in my opinion.

I guess I could use the extra cash along with my $400 surplus each month to invest in tax-free principal-guaranteed growth vehicles. What are some examples?

EXACTLY... see the explanations above ;~)

Cheers,
Dave Donhoff
Leverage Planner

Tony,

Forgot your last Q, sorry;

Okay if my screen name hasnt given me away, what does recourse mean for Texans?

"Recourse" means being able to "get back at you" or "get revenge" or "get recompensation" (depending on your perspective.)

"Full recourse" in the lending world means that if you borrow $100,000, and only pay back $70,000 (for example,) the lender can sue for judgment of the remaining $30,000, and if they win can pursue you to pay that judgment.

"Non-recourse" means that the lender cannot pursue you for any amount other than what the collateral will get for them at re-sale.

SPECIFICALLY, in regards to Texans, it is a somewhat complex conversation... depends on whether the financing in question was for the purchase or equity re-access, and whether it was on a declared (or default) homestead property or not. If in doubt, best to ask a Texas real estate attorney.

Not that I would just up and walk out of the mortgage, but if real estate prices continue to tumble and I become upside-down, can I walk? Should I walk? Can I keep the cash I have in these other liquid investments? Or will the mortgage company try to go after them?

If in doubt, best to ask a Texas real estate attorney.

Cheers,
Dave

Hi everyone,

I have tried to read through all of these posts and make sense of all of it, though I have a very limited understanding of finances. I'm hoping someone can give me a bit of info/advice .

Here is my situation:
- I am 34
- single
- currently renting an apartment in Los Angeles
- looking to purchase a house in Los Angeles
- have as stable of a job as one can have in this economy
- have enough saved to buy a house in my less preferred areas and enough to almost buy a house in other areas that I would prefer
- I am not very good with finances though have been very fortunate to have a good job and have lived somewhat thrifty for many years
- I am somewhat risk adverse after losing around $12k in the stock market back in 2000-2001
- I would like to buy a house sometime in the next year when I think prices get closer to what I anticipate to be the bottom
- all of my savings are currently divided between multiple savings accounts in banks, obviously not earning much interest, though it is FDIC insured

With all of that said:

1. I am wondering how to figure out how much $ to put down on a house or whether to try to almost buy one outright? Being risk adverse in this uncertain economy, my options really are FDIC backed banks or something similar, or putting it into a house. If looking at this decision based on potential interest earned in the bank vs. the amount paid to a lender for a loan, it would seem to me that the 2% being compounded in the savings account is less than the 5-6% I will be paying for the loan, right, making more sense to buy the house then earn less in savings interest. The plan would be to put a large amount down though keep a large amount in the bank for emergencies.

2. How do I calculate how much $ I will save by deducting interest from my taxes? I do not know which tax bracket I fall in, though I earned around $115,000 last year.

3. I am also a bit concerned after reading all the doom-and-gloom stories about our economy and the future value of the dollar. I do not really understand much about economics, though I am hearing some forecasting that at the rate our debt to other nations is growing, the value of the dollar will plummet in a few years. Is there any likelihood of this really happening? If so? I am guessing it will mean all of the $ I have worked so hard to save over the years will not be worth as much and it might make sense to put more of it into a house now? Can anyone comment on this?

4. I am also concerned about bank failures, even with FDIC insurance. I have been told that FDIC insurance guarantees you will get your money back, though they do not guarantee to pay it back all at the same time and they can do it over many years. Is this true?

Thank you for any info/input!!!!!

Hi Stanw,

1. I am wondering how to figure out how much $ to put down on a house or whether to try to almost buy one outright? Being risk adverse in this uncertain economy, my options really are FDIC backed banks or something similar, or putting it into a house.

The most conservative position is always to keep as much cash as required to cover all contingencies. If you run the numbers, the amount of any additional cash you might bury into a down payment would have otherwise carried you through many months (or even years) of safety by covering interest costs if you had to do so without a job, or in the face of unforeseen loss or desperation.

Always remember;
EVERYONE should eliminate their mortgage, but ONLY after they can actually aFford the risks of doing so (i.e. when they can aford to write a single check, and still have enough cash and working capital left over for a relatively low-risk lifestyle from that point onward.)

Even if you have 100% of the cash necessary to buy a house today, and even if we are at a market bottom in Los Angeles... unless you ALSO have enough remaining cash left over AFTER the purchase to cover all uninsured, unforeseen contingencies, AND enough income-producing assets to cover your lifestyle should you be unable to work.... a mortgage is your best cash protection.

If looking at this decision based on potential interest earned in the bank vs. the amount paid to a lender for a loan, it would seem to me that the 2% being compounded in the savings account is less than the 5-6% I will be paying for the loan, right, making more sense to buy the house then earn less in savings interest.

You can grow your funds in equally insured, compounding universal insurance accounts, tax-FREE, with guaranteed fixed rates of 5%, with options of selecting fixed-indexed credits that match the upside of any annual stock market index increases, but protect against any loss of your principal in stock market decreases (an "upward-only" ratcheting of your funds, annually.) NET/NET (even after the costs of the actual term insurance coverage) that outperforms at-risk market funds (and blows the doors off the 2% savings & CD strategies.)

That beats the pants off traditional banking products, and has the equally perfect record compared with FDIC insurance (nobody has ever lost their principal deposits in FDIC or private industry insured fixed or indexed accounts.)

The plan would be to put a large amount down though keep a large amount in the bank for emergencies.

Covering for emergencies is smart.... optimizing your safe growth plans is smartest.

2. How do I calculate how much $ I will save by deducting interest from my taxes? I do not know which tax bracket I fall in, though I earned around $115,000 last year.

How to calculate marginal tax rate

2008/2009 Tax Bracket Thresholds

THEN... use this formula;
(Face Interest Rate) multiplied by (1 - Marginal Tax Rate) = After-Tax Mortgage Interest Rate

3. I am also a bit concerned after reading all the doom-and-gloom stories about our economy and the future value of the dollar. I do not really understand much about economics, though I am hearing some forecasting that at the rate our debt to other nations is growing, the value of the dollar will plummet in a few years. Is there any likelihood of this really happening? If so?

FIRST OF ALL... recognize that ALL things occur in cycles... some are larger/longer cycles, some are shorter (even much shorter.) After some 12-15 years of raging long-run bull markets (with the 2000/2001 stock collapse being immediately replaced by a real estate orgy,) we are now in a downward cycle... it is 100% normal, non-surprising, expectable... and completely survivable for those who live responsibly and don't freak out.

NEXT.... YES!!!! Impending inflation (the collapse of the value of a cash-dollar held personally) is *ALREADY* occuring, and picking up steam. Most of the most savvy market analysts are predicting double digit inflation beginning as early as next year, and some are calling for the potential of inflation in the U.S. into the 20%s and even 30%s within the coming 3-10 years.

Virtually NOBODY is calling for no (or even just "low") inflation going forward from the mid to long term.

I am guessing it will mean all of the $ I have worked so hard to save over the years will not be worth as much and it might make sense to put more of it into a house now? Can anyone comment on this?

Not "into a house" as in "down payment" because if you do you will lose out on one of the hugest ways to protect yourself AGAINST inflation.

If you see what is coming, you want to do this;
A) Borrow dollars at TODAY'S dollar value, locking in the specific number of dollars (example, $100,000 in 2009 dollar value,)
B) Pay interest for it at less than the rate of real inflation (real inflation = double digits, real after-tax interest = sub-5%,)
C) Pay back the actual loan principal itself in FUTURE depreciated-value dollars (example; after 20 years the 2029 dollar will be worth significantly less than HALF the value of 2009 dollars... so paying off a loan of $100,000 borrowed in 2009 dollars... but using $100,000 of dollars received in 2029 is the equivalent of having HALF of your loan PAID FOR YOU BY THE CAUSE OF THE INFLATION ITSELF!)

Inflation is caused by the injection of imaginary money (money not backed by anything) into the economy by one or several governments, OR by private industry extending credit (which is also "imaginary money.)

1) Credit offerings have collapsed FAR below the norm... and this is also only a temporary cycle,
2) Governments all over the world (ESPECIALLY the U.S. government) is running the imaginary-money printing presses and flooding the markets with imaginary buying power at a rate never before seen in human economic history.

If you borrow (safely, responsibly,) at todays dollars... the government and the return of the credit industries will pay off a massive amount of your future debt, merely from the effect of inflation.

4. I am also concerned about bank failures, even with FDIC insurance. I have been told that FDIC insurance guarantees you will get your money back, though they do not guarantee to pay it back all at the same time and they can do it over many years. Is this true?

If never heard of the FDIC stringing out bank-failure beneficiaries... but in all of the economic U.S. history, no FDIC-insured bank depositor has ever not been made whole, and no state-fund insurance-covered cash contract holder had ever not been made whole.

Nobody can guarantee that the private reserve insurance nor the federal reserve insurance schemes will remain perfectly safe and reliable in the future... but they both have perfect track records looking in the past.

Cheers,
Dave Donhoff
Leverage Planner

Hi Dave,

Thanks for taking your time to respond!!! I'm going to go through your response in detail and I might have some follow-up questions if you do not mind :-)

Stanw,
You are welcome (of course!) and no worries about follow-on questions. Bring 'em on... if they get too detailed we can always go "off boards."

Cheers,
Dave Donhoff
Leverage Planner

Dave,
Assuming that inflation does kick in big time like everyone is expecting, does this necessarily mean that interest rates will climb accordingly? has there been a precedence where inflation was high and rates low? Thanks.

Hi NCRG,

Assuming that inflation does kick in big time like everyone is expecting, does this necessarily mean that interest rates will climb accordingly?

The answers are "it depends" and "not always, nor necessarily."

As I consider the question, we then have to dive deeper to establish the distinction of "WHICH rates?"

Interest rates for borrowing are a tail that wags behind the dog of interest credits guaranteed to buyers/investor of bonds. Different classes and types of bonds have different maturity dates. The duration (life-span) of the bond gives the buyer of the bond a degree of certainty of return against anticipated uncertainties.

Inflation is only ONE (albeit a huge one) factor that can affect the crediting or returns-earning on an investor's dollar. When a bond buyer anticipates that the value of their cash-currency will be degraded (i.e. inflation) to some degree of anticipation over a period of time, the bonds with that time duration will have to have a 'premium' interest credit over alternative duration bonds in order to "win" the investor's purchase.

SOME would argue that the current pricing of longterm bonds actually reflects the general market's foresight of LOW inflation... but this could only be true if the bond pricing was determined in a vacuum with no input EXCEPT anticipated inflation. Instead, bonds are being hammered for lack of confidence in the issuers (including the U.S. treasury.)

True sentiments about impending inflation can be deduced from the market's valuation of non-issuer hard assets (i.e gold, silver, durable commodities.) These fail to generate any yield (they just sit there, they don't spit out earnings, interest or dividends,) but they aren't affected by political policy; they can't be created out of thin air thereby diluting the value of all previous assets.

has there been a precedence where inflation was high and rates low?

Absolutely... but I can only say that so blatantly because you left the variables so ambiguous.

There are often times when immediate inflation is sky-high (think about when housing prices were doubling every 3-5 years in certain markets,) yet both the national long term interest rates, and even the local long term bond interest rates were DROPPING.

The reverse can occur as well... look at the current deflation of real estate... yet, because of the withdrawal of availability (qualification-ability) of mortgage credit, if you wanted to borrow the equivalent amount of money today over 80% of your home value, compared to 2004, you would have to pay a much higher blended rate of interest.

Why? In 2004 mortgage rates were a bit higher than today... but if you owned a $100,000 home you could use it to collateralize $100,000 of working leverage at, say, a total cost of 7%.

TODAY, (all income, credit, etc) equal) you might be able to borrow the 1st $80,000 at 5%... but the last $20,000 would have to be acquired on an unsecured basis at probably 12-25% interest rates... bringing your blended costs of interest on the same comparative dollar to more than 7%... DESPITE the deflation of the markets.

FURTHER... when talking "inflation/deflation" (as you may have already surmised,) we have to distinguish WHICH MARKETS we are talking about.

CURRENTLY we are seeing a strong INFLATION in consumer food goods. Milk, bread, eggs, and my wife's favorite aphrodisiac (chocolate) are on the rise.
We're seeing mid-term DEFLATION in fuel prices (after a nightmarish overnight spike of INFLATION.)
We're seeing a long-term DEFLATION in real estate prices.
Some markets are seeing inflation in rents, some are seeing deflation.

SO... you asked a simple, innocent enough question. Have I mucked it all up sufficiently with details? ;~)

Cheers,
Dave Donhoff
Leverage Planner