Borrow Smart Retire Rich
Todd Ballenger is now a professional author and speaker but his career began in the financial services industry. In fact, during his career he has held licenses to act as a Realtor, life insurance agent, financial planner, and mortgage loan officer.
His unique perspectives from each of his endeavors has led him to create what he calls his, “7-step process for managing the wealth in your house” which he outlines in his book Borrow Smart Retire Rich.
Here are my notes & lessons from the book:
* In 2005 real estate equity accounted for 61.2% of the average US household’s net worth (over the time period 1952-2005 the average was 19.9%.
*Waiting to buy a home can prove a costly mistake. I blogged about this concept at this link.
*Financial advisers typically seek to balance their clients’ assets based on their desire for safety, liquidity, and return. You can also apply these criteria when making decisions regarding the best mortgage structure on a house.
*Net worth: Most people understand that a household’s net worth is equal to: Assets – Liabilities. However, most people don’t realize that the specific location of their assets and liabilities is an extremely important concept on the path towards wealth creation. Here is a link to a blog posting about this concept.
*Playing defense in a depreciating market: “The key to avoiding loss of wealth in a depreciating market is having the flexibility to wait for the market to recover.” For me this means having liquidity.
*Home equity is not a very “liquid” asset. The only way to access your homes equity is to sell it or take a loan out against it.
*Life events which can impact a person’s ability to access their home’s equity through a loan:
a) Job loss/ Career Change
b) Lawsuit against homeowner
c) Forced early retirement
d) Income changes
g) Home value change
h) Tax lien
i) Marriage/ divorce
j) Identity theft
*Making principal payments: See this blog posting.
*House equity has no return on investment: “If you invest $40,000 and the investment is still worth $40,000 after 30 years, your investment has earned a 0% return. It has had no growth. Thus, the ability of your house to influence your net worth boils down to whether or not the house’s value appreciates or depreciates over time.”
* Net after tax borrowing cost: “When you borrow money against the value of your house at 7%, the lender will earn a 7% return. If you are in a 32% federal and state tax bracket, and your interest is tax-deductible, then….your actual cost of borrowing is 4.76%.”
*On paying off the mortgage versus saving the money: “…many of us with a mortgage believe that the mortgage should be paid off before we start getting serious about saving. However, that approach has some hidden costs. For one thing, it means losing time to allow investment earnings to compound.”
*Calculating the cost of prepaying the mortgage versus saving-click this link for more
*The idea of shifting wealth away from the home and into savings/ investments which earn a higher EPR comes with “discipline risk”. This is the risk that the homeowner will not use the savings productively and will instead use it to consume non-appreciating goods.
* Buying a house 100% with cash employs no leverage. If one uses a mortgage to buy a home then leverage is employed enhancing return on investment.
* Factors that go into determining how much leverage to use in buying a home:
a) Risk Tolerance
b) Time Horizon
c) Net after tax cost of borrowing
d) Need for liquidity
e) Goals for real estate
* Ballenger equates equity in one’s home to bond holdings in evaluating a household’s investment mix. This is because equity represents money invested in the house which saves on interest expense at a rate similar to long bonds.
*Click this link for a great metaphor about learning to manage wealth.
* Using a strategy to reposition equity away from the house and into assets out of the home (that carry a higher return than the net cost of borrowing) can create substantial wealth over time. However, a more traditional amortizing loan may prove to be a better option for a household that does not display discipline with their spending habits.
* Option payment ARMs represent the most effective tool for building wealth so long as the rate of return on equity invested outside of the home exceeds the net cost of borrowing AND discipline is exercised.
*Click this link to learn about financial arbitrage and how it applies to borrowing out of necessity and borrowing out of opportunity.
*Click this link to learn about why every home purchase is made with 100% financing.
*Top reasons for a new mortgage (and hense an annual mortgage review)
a) Deciding to sell your house sooner than expected OR deciding to stay in a home longer.
b) Deciding to remodel
c) Change in marital status
d) Birth of a new baby
e) Change in income
f) Change in tax status
h) New investment or business opportunity
i) Change of employment or job location
j) Major illness
k) Change in value of home
l) Change in interest rates