I was watching some of the Saturday morning business shows on Fox today, and decided to post on this matter. Cavuto had a real estate broker as a guest, and she was talking about how home ownership "creates wealth". I know a little about this, and wanted to post my thoughts.

Myth 1: Homeownership creates wealth

First and foremost, I want to make a distinction between OWNING a home and having a mortgage. Personally I consider home ownership to be not having a mortgage, because if you have a loan you don't really own the home, you simply have a large amount of debt which you used to finance a house with.

Secondly and more importantly, I don't see any realistic way in which simply owning a home builds wealth. Sure, real estate values cyclically and continuously go up, but what does it matter? The equity in a home doesn't bring you a rate of return. If the price of your house goes up 100k, nobody is going to write you a check for 100k. The money is not liquid. Unless you SELL the home, you gain nothing. And if you sell the home, what about the ownership part? That goes away.

Furthermore if you sell the home for a higher price than what you paid for it, you'll also have to remember that comparative prices for homes are also higher. If you are not a real estate investor, and are not buying property in times like this and selling in times like those that existed three years ago, the only thing the an increase in 100k in the value of your home will bring you is the ability to get MORE into debt, by borrowing more money.

(And maybe THIS is the root of the credit crisis, and offerings cheap money - namely, the idea that owning a home and having a mortgage, or the ability to have a larger mortgage somehow creates wealth.)

Myth 2 - Mortgage Interest Rates Matter

This is absolutely false. What the rate on you mortgage is doesn't matter in the least.But everyone seems to get caught up in that somehow. When fixed rates drop, people tend to clamor to refinance.

Regardless of that, here's why mortgage rates don't matter. There are three things which affect how quickly you pay off your mortgage. They are:

1. Length of duration or term
2. Amount borrowed
3. Interest rate

YOU, the consumer, control two out of those three, NOT the banks and lenders. YOU, the consumer decide the length of the loan and the amount you borrow. The banks only decide the rate, and as such, the idea that they have power over you mortgage is laughable.

I'll explain further - just because it's advertised as a 15-year fixed or 30-year fixed, doesn't mean you simply HAVE to make that payment. You can pay more. How much more is a matter of opinion...

Now I have heard lenders supposedly educating consumers by telling them of a little "trick" - paying an extra payment once a year and having that cut something like 7 years off a 30 year mortgage.

Mm hmm

I have NEVER heard ANYONE tell a consumer, that because of how mortgage loans are amortized, if a consumer were to simply pay a DOUBLE payment each month, they would pay off a 30-year mortgage in 6 years. 72 months. Regardless of rate.

Amortization refers to how much of the monthly payment goes to principle and how much goes to interest. On a 30-year mortgage, in the first 5 years, about 80% goes to interest....

So why would ANYONE willingly agree to pay TWO dollars in interest for every ONE dollar borrowed? That's the case on a 30 year mortgage - if you borrow 250,000, and pay the regular payment, by the end of the thirty years you will have paid back that initial 250,000 AND an ADDITIONAL 500,000 in interest to the lender.

However,

because of the nature of amortization, again, REGARDLESS OF INTEREST RATE, on a thirty year mortgage - if you borrow that same 250,000, and pay double the monthly payment EACH month, in a short six years, not thirty, you will have paid back that 250,000 you borrowed and about 50,000 in interest to the lender.

This is extremely significant - this is the difference between between paying two dollars in interest (200% total) for every dollar borrowed and paying 20 cents (20% total) for every dollar borrowed.

Does this mean that it's irresponsible for lenders to write loans that allow for up to 50% of a customer's monthly income to be devoted to the minimum loan payment? Obviously that person won't ever likely be able to pay a double payment, as that will be 100% of that individual's monthly income, and more than likely said person won't ever pay off that mortgage. I don't know if such loans, and guidelines, which are the norm, and will probably always be the norm, are irresponsible. But I will say an educated consumer probably won't ever ever allow for more than 25% (or so) of total monthly income to be set aside for the minimum payment. Thusly, a double payment would equal 50% of monthly income and would allow that person to pay off the mortgage in 72 months.

Lastly, there is NO such thing as "good" debt, even though some at CNN and FOX would like you to believe there is. Equity doesn't earn a rate of return, and equity is not an asset. A home is a place for you and your family to live in, and hopefully without a mortgage. Thanks for reading.

Good stuff!

But, I do have a question... Isn't equity in a home like a bank account that can be used as collateral?

And, if that is the case, wouldn't that be considered a 'form' of wealth?

quote:

Originally posted by DCookeUSA1:

Well I agree to a certain extent with some of what you have said but here is where I disagree.

Here is how a home builds wealth. Notice I didn't say builds cash.

1) A basic need of any human being is shelter. Its one of the big three. Your going to be paying for it unless its a box in some alley. And as such your monthly payments etc might as well go into something from which there is a return.

2) No matter who you are your gonna have to put your money somewhere. Now you can simply stuff it into your matress at which point inflation will gradually eat away at its value. Or you can convert it to an asset (like a home) which appreciates and thus keeps the value constant over time and with inflation.

3) The home can be passed to offspring once you pass and thus increase your families wealth over time. It is likely in todays age that by the time your children inherit it if they had already purchased a home that they could convert it to cash and use that cash to pay off their own home and thus use their salary to further expand their wealth as opposed to paying off a mortgage. Or of course you can convert it to cash and use it to pay for your retirement home.

4) A home is nearly as good as cash if you have paid even a remote amount of it off. Its called equity and it allows you to barrow for the things you need like sending your kids to college or whatever. Unlike standard loans that you just pay interest on it allows you to write the interest off. Not that the write off equals the interest paid but its better than nothing. Its better than a standard interest bearing loan.

Now if your going to get in debt. The best debt you can have is debt to purchase assets that appreciate, debt that better enables you to make money be that continued education or equipment for your business, etc.. And the best kind of debt is the kind you can write off the interest payments.

When you compare the equity value of your home in most cases (the current day and time withstanding) you will find that it keeps your money valued with inflation better than most 3% or 5% type of investments. And with few exceptions it is a relatively safe investment.

Obvously if you have the means to purchase everything with cash then thats far better. But MOST people don't have the means when it comes to a home. Of course it doesn't make any sense to by a home for cash and then barrow for a car or a boat or something. Better to use the loan on the house and the cash for the car or boat.

This message has been edited. Last edited by: floersh,

quote:

Originally posted by SwtDivaLove:
Good stuff!

But, I do have a question... Isn't equity in a home like a bank account that can be used as collateral?

And, if that is the case, wouldn't that be considered a 'form' of wealth?

Yes it can be used as collateral for more borrowing, but unless you are using some form of arbitrage, it isn't really wealth. An example of arbitrage: taking out an equity loan at 7% and putting that money elsewhere where it's earning 8% interest and pocketing the difference. OR putting that money to work in some other way such as starting a small business, where rates of return can be 20%-100% per year on your investment.

Remember if you borrow you still have to pay it back. You want to be RECEIVING a rate of return, not paying one.

floresh,

On your second point, yes, home values will appreciate and give you a rate of return(in that sense) and help you beat inflation. HOWEVER, it doesn't matter unless you choose to sell your home and realize the gain, which negates your first point.

As long as it's sitting in equity the perceived rate of return doesn't matter and is unrealizable. As I mentioned, if your home appreciates 100k, no one is going to cut you a check for 100k without expecting that money to be paid back with interest.

As another example: let's say I have $250,000 in mutual funds. If the market moves higher and my investment is now worth $300,000, does that mean I have assets totaling $300,000 in mutual funds? The answer is NO, not unless I SELL my mutual funds and realize the gain. At that point I can then wait for the market to correct and purchase $250,000 in funds once again. In this example, the market could just as easily dip and my $250,000 could be worth $200,000, SO an unrealized gain is not really a gain.

So, if home equity appreciates and isn't realized by the sale of the home (and why would you want to do that if it's your primary residence and you wish to pass it to your children), then as unrealized gain it's worthless.

Additionally, keep in mind that inflation is constant, so if your kids decide to sell it and use the cash for their own home purchase, home prices will be higher OVERALL, thus your kids won't be realizing any net benefit because it's not as if only YOUR home became more expensive - everyone else's did too.

In my view, true wealth is not having to pay interest, being able to keep your money, and having enough money "working" for you and bearing interest for YOU that you'll be able to live off the interest YOU receive. And that means not having any debt, including mortgage debt, and saving and using your own liquid assets to generate income for you.

There are, of course, positives and negatives to purchasing a home with a mortgage. Not the least of which in the negative side is the mortgage. Note here, home mortgage interest is a tax deductable item, a valuable thing in itself mitigating the interest costs.


The best of all worlds would be to purchase a home without having a mortgage, or your buying a multiple dwelling as a residence and having your tenants carry the freight for you.

Always remember, you will have to pay for your shelter in one form or another, and, in my opinion, ownership of that dwelling has more value to me than being a tenant.

quote:

Originally posted by DCookeUSA1:

All you are arguing is liquidity. But that makes no never mind as it relates to assets. No one with real money holds it in cash. They all hold it in assets of various types be it mutal funds, stocks, real estate, commodities, etc..

Its all a matter of where you put your money. Cash is absolutely the worst as it simply devalues over time due to inflation. Its got to be converted to something that will maintain its value and possibly even make you money.

And its those who disagree that are the same ones complaining about the wealthy being the only ones benefiting from the elimination of the death tax and or capital gains tax.

And there is someone who will hand you a $100K check on your equity without the need to pay anything off. That person is called a new home owner.

As for your kids. Yes the home cost will be higher. But that does not negate the reality that they will have a house without themselves putting much if anything into it. And they will be an owner without a loan and thus interest payments. Every penny you and I throw into mortgages and or rent can be spent on something else. And the value of that house will continue to rise through their lifespan keeping up with the cost that their children are likely to pay on a new house when they grow up.

If you don't want to buy a home thats fine. But don't complain about the rich and the death tax. Because there isn't a wealthy person on this planet that doesn't own a home and most likely other real estate as well. A home CAN build wealth. It just may not be your wealth! More likely your childrens and or grand childrens.

quote:

Originally posted by floersh:

quote:

Originally posted by DCookeUSA1:

All you are arguing is liquidity. But that makes no never mind as it relates to assets. No one with real money holds it in cash. They all hold it in assets of various types be it mutal funds, stocks, real estate, commodities, etc..

Its all a matter of where you put your money. Cash is absolutely the worst as it simply devalues over time due to inflation. Its got to be converted to something that will maintain its value and possibly even make you money.

And its those who disagree that are the same ones complaining about the wealthy being the only ones benefiting from the elimination of the death tax and or capital gains tax.

And there is someone who will hand you a $100K check on your equity without the need to pay anything off. That person is called a new home owner.

As for your kids. Yes the home cost will be higher. But that does not negate the reality that they will have a house without themselves putting much if anything into it. And they will be an owner without a loan and thus interest payments. Every penny you and I throw into mortgages and or rent can be spent on something else. And the value of that house will continue to rise through their lifespan keeping up with the cost that their children are likely to pay on a new house when they grow up.

If you don't want to buy a home thats fine. But don't complain about the rich and the death tax. Because there isn't a wealthy person on this planet that doesn't own a home and most likely other real estate as well. A home CAN build wealth. It just may not be your wealth! More likely your childrens and or grand childrens.

Ok, one way you can convert your home into a cash-producing asset is to pay off the mortgage, rent the property out, and then gift the property to your kids. They can then use the positive cash flow generated from the rent to pay the cost of their own mortgage. This is one way you can earn a realized rate of return on your home.

Your point about liquidity having nothing to do with assets isn't correct. I wasn't talking about liquidity, because even real estate can be liquid. I was talking about realized gain vs. unrealized gain.

Furthermore, I wasn't saying that purchasing a home is a bad idea, but I do think that many people buy a home and don't realize that a some can be both an asset or a liability. More than likely, it'll be a liability unless you take it one step further and convert it to an asset somehow. Paying a mortgage and/or simply having the equity sit there = liability. Having no mortgage debt and/or realizing gain from the sale or rental of the property = asset.

quote:

Originally posted by DCookeUSA1:

Ok, one way you can convert your home into a cash-producing asset is to pay off the mortgage, rent the property out, and then gift the property to your kids. They can then use the positive cash flow generated from the rent to pay the cost of their own mortgage. This is one way you can earn a realized rate of return on your home.

If the kids were smart they would sell the property and use the proceeds to buy a house without a mortgage at all. If they want to run a mortgage it should be the rental property that the mortgage is held against. There are tax advantages.

quote:

Originally posted by DCookeUSA1:

Your point about liquidity having nothing to do with assets isn't correct. I wasn't talking about liquidity, because even real estate can be liquid. I was talking about realized gain vs. unrealized gain.

Unrealized gain is better than realized loss which is the part of the argument you seem to be leaving out!

For example a Mercedes or Hummer is a garuntee realized loss of emence porportions.. Cash purchase or not.

To the best of my knowledge and experience the only investment that has a better return on investment and at the same time is as safe or safer is a high quality secondary and terinary education.

quote:

Originally posted by floersh:

quote:

Originally posted by DCookeUSA1:

Ok, one way you can convert your home into a cash-producing asset is to pay off the mortgage, rent the property out, and then gift the property to your kids. They can then use the positive cash flow generated from the rent to pay the cost of their own mortgage. This is one way you can earn a realized rate of return on your home.

If the kids were smart they would sell the property and use the proceeds to buy a house without a mortgage at all. If they want to run a mortgage it should be the rental property that the mortgage is held against. There are tax advantages.

I don't want to get into taxes because that's beyond the scope of this thread. As far as realized loss goes, if your kids were to sell the property and use the lump sum to buy their own home, as opposed to keeping the home for rental purposes and collecting the rental money "rate-of-return" and using that to pay their own mortgage off on a SEPARATE house, in a very real sense this a realized LOSS, as that lump sum won't earn them a rate of return. However, rental income in a very real sense is a rate of return that could last for many lifetimes.

Unrealized gain is not fundamentally different from realized loss because unrealized gain has an equal chance of becoming either realized gain or realized loss.In this sense, unrealized loss is also not fundamentally different from realized gain, because that unrealized loss also has an equal chance of becoming either realized gain or realized loss.

Lastly, running a mortgage against a rental property isn't any smarter than running a mortgage against a primary residence with no rental income. No such thing as good debt.

To transfer the title to your kids safely prior to your death, you must create a living trust. To be very safe, it must be irrevokeable, but the amount you may place in the trust, cash or appraised valus is only $1,000,000 or there's tax due.

The $ may seem like a considerable amount today, but with a depressed realestate market and sky high comodities markets, therte WILL be a correction for real estate in the future, upowards, a considerable amount too.

A friend moved, about 25 years ago, his farm, valued at the time just under $200,000 , into a living trust. Today, the property is worth over $5 million. It is never too soon to create a trust for your children.

quote:

Secondly and more importantly, I don't see any realistic way in which simply owning a home builds wealth. Sure, real estate values cyclically and continuously go up, but what does it matter? The equity in a home doesn't bring you a rate of return. If the price of your house goes up 100k, nobody is going to write you a check for 100k. The money is not liquid. Unless you SELL the home, you gain nothing. And if you sell the home, what about the ownership part? That goes away.

A. You aren't considering that the alternative, renting, builds nothing whatsoever.

B. You also do not consider that the federal government directly subsidizes homeowners in a way that provides no benefit to renters, since mortgage interest is tax deductible and other forms of interest are not.

That doesn't guarantee that you will build wealth ... but it does give you one of your best opportunities to do so.

quote:

Originally posted by DCookeUSA1:

Lastly, running a mortgage against a rental property isn't any smarter than running a mortgage against a primary residence with no rental income. No such thing as good debt.

If thats what you believe then I am sure you'll never be wealthy..

quote:

Originally posted by oldmole:

quote:

Secondly and more importantly, I don't see any realistic way in which simply owning a home builds wealth. Sure, real estate values cyclically and continuously go up, but what does it matter? The equity in a home doesn't bring you a rate of return. If the price of your house goes up 100k, nobody is going to write you a check for 100k. The money is not liquid. Unless you SELL the home, you gain nothing. And if you sell the home, what about the ownership part? That goes away.

A. You aren't considering that the alternative, renting, builds nothing whatsoever.

B. You also do not consider that the federal government directly subsidizes homeowners in a way that provides no benefit to renters, since mortgage interest is tax deductible and other forms of interest are not.

That doesn't guarantee that you will build wealth ... but it does give you one of your best opportunities to do so.

I do think that home ownership is an advantage over renting, as renting builds nothing. Home ownership does provide OPPORTUNITY for wealth, whereas renting doesn't, but that opportunity has to be taken one step further in some way.

Furthermore, if I'm irresponsible and take on a mortgage which I'll never be realistically able to pay off with my income, is that really fundamentally different from renting? I would argue that an irresponsible person who tackles mountains of mortgage debt without the income to pay it off is worse off than that same person simply renting, since the consequences can be never being able to retire comfortably, foreclosure and horrible credit and less chance of being able to pay debt off as easily in the future.

And peter3_1, I agree with you -there are plenty of legal entities out there, such as trusts, which can provide a person and his/her kids with tax advantages and asset protection.

I also want to re-stress the importance of paying a double payment monthly on a 30-year fixed so the home can be paid off in 6 years. There are many ways to calculate this, such as Bankrate's online calculator. You'll notice rate is completely irrelevant, since if you pay double whatever your principle and interest payment is, you'll always pay the home off in 6 years.

quote:

Originally posted by DCookeUSA1:

quote:

Originally posted by oldmole:

quote:

Secondly and more importantly, I don't see any realistic way in which simply owning a home builds wealth. Sure, real estate values cyclically and continuously go up, but what does it matter? The equity in a home doesn't bring you a rate of return. If the price of your house goes up 100k, nobody is going to write you a check for 100k. The money is not liquid. Unless you SELL the home, you gain nothing. And if you sell the home, what about the ownership part? That goes away.

A. You aren't considering that the alternative, renting, builds nothing whatsoever.

B. You also do not consider that the federal government directly subsidizes homeowners in a way that provides no benefit to renters, since mortgage interest is tax deductible and other forms of interest are not.

That doesn't guarantee that you will build wealth ... but it does give you one of your best opportunities to do so.

I do think that home ownership is an advantage over renting, as renting builds nothing. Home ownership does provide OPPORTUNITY for wealth, whereas renting doesn't, but that opportunity has to be taken one step further in some way.

Furthermore, if I'm irresponsible and take on a mortgage which I'll never be realistically able to pay off with my income, is that really fundamentally different from renting? I would argue that an irresponsible person who tackles mountains of mortgage debt without the income to pay it off is worse off than that same person simply renting, since the consequences can be never being able to retire comfortably, foreclosure and horrible credit and less chance of being able to pay debt off as easily in the future.

And peter3_1, I agree with you -there are plenty of legal entities out there, such as trusts, which can provide a person and his/her kids with tax advantages and asset protection.

I also want to re-stress the importance of paying a double payment monthly on a 30-year fixed so the home can be paid off in 6 years. There are many ways to calculate this, such as Bankrate's online calculator. You'll notice rate is completely irrelevant, since if you pay double whatever your principle and interest payment is, you'll always pay the home off in 6 years.

The downside of this is that you must have enough disposable income in order to pay double the monthly payment.

How many people do you know who are able to do that?

Also, it is said that on a 30-year mortgage, if you make just one extra payment a year, it takes a year off on the other end.

quote:

Originally posted by floersh:

quote:

Originally posted by DCookeUSA1:

Lastly, running a mortgage against a rental property isn't any smarter than running a mortgage against a primary residence with no rental income. No such thing as good debt.

If thats what you believe then I am sure you'll never be wealthy..

Ok, since you're so concerned about passing your home onto your children, let me as you this: what's better for them - giving them a home with both a mortgage and rental income or giving them a home with no mortgage and with rental income? Which would be more beneficial to them?

But we seem to disagree on the benefits of unrealized gain. Hypothetically if someone purchased a home in 1998 for $250,000 with the hopes of passing their home onto their kids, and today is facing foreclosure and being forced to sell that home at a loss or having to do a short sale, that person might disagree with you on the benefits of unrealized gain, assuming their property was worth more, say in, 2005 than what they bought it for in 1998, but worth less today than what they bought it for in 1998. Just a hypothetical on the gamble that is unrealized gain.

quote:

Originally posted by SwtDivaLove:

quote:

Originally posted by DCookeUSA1:

quote:

Originally posted by oldmole:

quote:

Secondly and more importantly, I don't see any realistic way in which simply owning a home builds wealth. Sure, real estate values cyclically and continuously go up, but what does it matter? The equity in a home doesn't bring you a rate of return. If the price of your house goes up 100k, nobody is going to write you a check for 100k. The money is not liquid. Unless you SELL the home, you gain nothing. And if you sell the home, what about the ownership part? That goes away.

A. You aren't considering that the alternative, renting, builds nothing whatsoever.

B. You also do not consider that the federal government directly subsidizes homeowners in a way that provides no benefit to renters, since mortgage interest is tax deductible and other forms of interest are not.

That doesn't guarantee that you will build wealth ... but it does give you one of your best opportunities to do so.

I do think that home ownership is an advantage over renting, as renting builds nothing. Home ownership does provide OPPORTUNITY for wealth, whereas renting doesn't, but that opportunity has to be taken one step further in some way.

Furthermore, if I'm irresponsible and take on a mortgage which I'll never be realistically able to pay off with my income, is that really fundamentally different from renting? I would argue that an irresponsible person who tackles mountains of mortgage debt without the income to pay it off is worse off than that same person simply renting, since the consequences can be never being able to retire comfortably, foreclosure and horrible credit and less chance of being able to pay debt off as easily in the future.

And peter3_1, I agree with you -there are plenty of legal entities out there, such as trusts, which can provide a person and his/her kids with tax advantages and asset protection.

I also want to re-stress the importance of paying a double payment monthly on a 30-year fixed so the home can be paid off in 6 years. There are many ways to calculate this, such as Bankrate's online calculator. You'll notice rate is completely irrelevant, since if you pay double whatever your principle and interest payment is, you'll always pay the home off in 6 years.

The downside of this is that you must have enough disposable income in order to pay double the monthly payment.

How many people do you know who are able to do that?

Also, it is said that on a 30-year mortgage, if you make just one extra payment a year, it takes a year off on the other end.

I mentioned this in my first post - that one extra payment per year will shave off about seven years off a 30-year mortgage.

The solution is to find out what you can pay as a payment and what rate you qualify for, and how much that will allow you to borrow, then divide by two and get a loan for that final amount. Either that or find a way to make more money.

That's the unfortunate nature of amortization, for a full 30 years you'll pay two dollars in interest for every dollar you borrow, so if you buy a $250,000 house you'll end up paying around $750,000 total, assuming no refinancing, which starts the cycle all over again. But at least we can beat the cycle by paying double, in which case a $250,000 house will end up costing only $300,000 after 6 years. Taking into account total interest cost is very important to building wealth and securing a future for your children, in my view.