Jason Flurry, CFP
How to turn your home into one of your best performing assets and make college more affordable
From time to time I find that I end up having some of the same conversations with my private college planning clients as I do with my private financial planning clients. The financial planning expertise I have serves as a bridge between building a successful college plan and doing so in the context of someone’s overall life plan.
I’ve said before that next to the purchase of a home, paying for college is probably one of the largest financial transactions you’ll make in your lifetime. When you have four kids going to college like I do, collectively it may be THE largest financial transaction. And normally, I say right here that we shop for houses much differently than we do colleges – and that’s true. But it’s easy to adopt mindsets about both college and your home that aren’t necessarily working in your best interest.
And here’s the thing – you don’t even know that they’re not working in your best interest, because it seems like everybody believes the same things.
It’s like, how can everybody be wrong? But, let me ask you this question. If everybody’s following the same advice when it comes to things like preparing for college, saving for retirement, and paying off their mortgage, why is it that so few people are financially prepared for retirement in America these days?
Depending on which study you look at, it appears that only 2-3 out of 100 people turning 65 today are financially independent.
Could it be that maybe the conventional wisdom that everybody believes to be true, isn’t so true? And here’s the bigger question. If something you’ve always believed to be true actually does turn out not to be true, when you want to know about it?
Well, hopefully, your answer is “right now” while there still time to do something about it.
In each article I post here, I share with you some of the insights that I found to be helpful in making college more affordable. And, if you been reading my stuff for any amount of time at all, you’ve probably noticed that most of what I share with you here is different than what you hear from your school counselor, from your family and friends, and even from other college advisors. There’s a reason for that.
My experience has been tested in the trenches, and I have first-hand experience with the things I share with you because I worked with over 900 colleges and universities and thousands of families to help them get their kids in the best colleges possible for the least amount of money possible. That experience and the years I’ve invested to become a College Planning Specialist puts me in a unique situation to offer you insights you won’t likely hear anywhere else. I hope you’re benefiting from that and I’m happy to be able to share with you some of what I learned.
In addition to planning for college, my financial planning background as a CERTIFIED FINANCIAL PLANNER™ professional and the president of a Registered Investment Advisory firm has also given me the same types of insights on how to build wealth and avoid making mistakes that can ruin your finances. In this article, I’m going to share with you a topic I covered recently in my financial planning podcast called The Financial Planning Blueprint.
If you’re like a lot of people, you may have saved a lot of money in retirement accounts and you may have a fair amount of equity in your home. In fact, you may even have it as a goal of yours to pay off your house, which is fine. Financial celebrities like Dave Ramsey encourage that and I agree with him in principle. But, when you have college to pay for and when you’re trying to make sure that you’re taking care of your best interest instead of providing for someone else’s best interest, managing your home equity inside your home may not be the best idea.
Shaking things up I know this is controversial, but follow along as I share how your home can become one of your best performing assets. See, owning a home has been a central part of the American dream for generations. It’s incredible how many people I meet that have paying off their mortgage as one of their financial goals. But is that really the best strategy to build wealth?
The answer to that question is found in the answer to two other questions: 1) Is your home an asset or a liability? and 2) do you have enough saved that you’ll never need any of your home equity to fund your retirement lifestyle?
Let’s look at the second question first. If your financial situation is such that you can pay off your mortgage and never need any of your home equity to fund other retirement goals, it probably doesn’t matter financially if you pay your mortgage off or not. Just make sure you have a good cushion in place as you do your planning so you don’t get into a bind late in life and have to sell your home or use a reverse mortgage to make ends meet. Losing control of your finances and worrying about running out of money before you run out of breath doesn’t make your golden year very golden.
So let’s now go back to the first question. Do you think of your home as an asset or a liability?
The majority of people I ask usually respond immediately that it is an asset. When I ask if they are sure that it is an asset, they pause and think about it, sometimes for the very first time, and answer with much less confidence than they did before.
To truly answer this question properly, you need to understand the difference between an asset and a liability. So, let’s define each one:
An asset can be easily defined as something that has value and puts money in your pocket.
A liability is the opposite of an asset. A liability is something that takes money out of your pocket.
So let’s look at your home again with these definitions in mind. You have things that take money out of your pocket each year like your mortgage payment, taxes, insurance and upkeep on the home. Take a moment and add those categories up and see how much they run you each year.
Now on the same sheet of paper, subtract the amount of your mortgage loan (if you have one) from the value of your home. Whatever that number comes to is your home equity balance and this is what most people think of when they classify their home as an asset. But let’s see if it really is an asset or not.
Just like we calculated how much money is coming out of your pocket each month with the liabilities you have related to your home. Now calculate how much income (money in your pocket) you’re receiving from your home each month to counter those liabilities and list that number beside them.
This is where some people get confused, so follow along closely here.
I’m asking you to list how much money you receive from your home equity asset, but if you really think about it properly, you aren’t receiving any money from the home equity you have. The value is just sitting there in the house waiting for you to sell it. But you’d have to live somewhere else if you moved, so it’s fair to say that that money in your home is not really working for you at all. It’s putting zero dollars in your pocket each month, right? So, since that’s the case, can we really classify it as an asset? No, we can’t.
Your home is really a liability. And to access the equity you have in it you have to sell and rent or get permission from the bank to refinance your loan. Neither scenario puts you in control or in a position to become wealthy in a way you can enjoy. So paying off your home may not be the best way to build wealth.
What are you thinking? Let me pause for a minute and acknowledge that I am probably testing some of your foundational beliefs with this tip so far. I understand your anxiety, but stay with me. You’ve been told your whole life that paying off your home is a smart idea, right? But why is it such a smart idea? You have to think about that and really understand what’s involved here to answer that question properly.
For most people they were told by their parents who were also told by their parents that owning their home outright was one of the best financial decisions they could make. But why? Tying up hundreds of thousands of dollars, maybe for the rest of your life, just to eliminate a much smaller mortgage payment doesn’t seem to be very prudent advice for most people. But let’s look at where that advice came from, and once you see it, you’ll understand why this concept of paying off your home is so hard wired into the brains of the last 3 or 4 generations.
Back in the 1920’s the stock market was booming. Money was easy to access and rich investors could borrow 90 cents on the dollar to buy a full dollar’s worth of stock. That high degree of leverage was very profitable until the market crashed in October of 1929 losing almost 25% of its value in just a couple of days.
The brokerage firms required investors to deposit more money against their borrowed shares, and since no one wanted to sell their shares at such a loss, they went down to the bank and pulled cash out to put into their brokerage accounts. Well, as you can imagine, the stock market crash made headline news around the world and when the regular folks in town saw the rich people of their town start withdrawing their money from the banks too, they went down and started taking their money out as fast as they could too. That created a run on the bank, which meant the bank had to raise money - and fast.
The only way they could do that was to call in the mortgage loans they had. So, all across the country banks started requiring people’s mortgages to be paid in full by the end of the month in order to avoid being foreclosed on by the bank. Imagine that happening to you today. Would you be able to pay your mortgage off on such short notice? Most of them couldn’t either, which meant many, many good people lost their homes for reasons that were completely beyond their control.
The banks couldn’t raise enough money, so many of them failed, and the stock market continued to drop until about 80% of it was gone just a few years later. That combination ushered in the Great Depression and it burned into the minds of people everywhere PAY OFF YOUR MORTGAGE! If you owned your home, the bank couldn’t take it from you no matter what happened.
But let’s review what happened after these devastating events that could make us think differently today.
Investors can no longer borrow so much to purchase investments, so the stock market can’t be as highly leveraged today as it was in the 1920’s. The government set up the FDIC so you would be protected if your bank suddenly got into trouble and failed. And finally, consumer protection acts were passed that said the bank couldn’t come and call in your mortgage early. As long as you were making payments in a timely manner, you were guaranteed to be able to keep your home for as long as you wanted.
So basically, the things that caused this financial death spiral in the 1920’s and 1930’s can’t really happen today. Yet people are still hanging on to the fundamental belief that you have to pay off your mortgage in order to be financially secure. But how do you become more financially secure investing your assets into a liability you have limited access to, especially during your retirement years? Outside of the emotional feeling that your mortgage has been paid, tying up all of that money into something that doesn’t pay you any money back doesn’t make sense.
Putting your home equity to work for you like an asset With that in mind, I’m going to show you how you can use your home equity like asset, save thousands in taxes, and still shave years off your mortgage so you can own your home free and clear faster than you ever imagined. And by the way, does the value of your home change based on whether or not you have a mortgage? No, of course not. Your home is going to be worth the same regardless. So let’s continue…
By repositioning the equity in your home to a conservative account, preferably something that’s accessible to you and guaranteed against losses, you allow it to begin putting money in your pocket each month. With that income increasing the amount of money you have on hand each year and with the amount of interest declining on your mortgage as you make payments each year, over time you earn far more than you pay.
Look at this example of how managing your home equity outside of your home helps you build wealth faster and stay in control of your assets. I’ve placed both the mortgage rate (net of your itemized tax deduction on mortgage interest) and the rate you earn in your side account at 4% for planning purposes. So even though it looks like they are a wash, you’ll see how the math works in your favor, making you more money than you would have otherwise had.
Since you only pay interest on the remaining balance of your mortgage, your payment goes down with each year you pay. In the account where your equity is positioned, you earn interest on the whole account, which is getting bigger each year. In just the first 6 years I’ve illustrated here, you could have earned an additional $10,873 by taking this approach AND your home would still be worth the same amount as if you had paid it off. Plus, you’re always in a position to pay the house off if you ever decide you want to because the side account is worth more than the mortgage every year. You’re just choosing to leave the mortgage in place because it costs you less than you are making in your account.
Your friendly banker is also smart Here’s one more important thing you need to know about paying your mortgage off early. And it is very counterintuitive until you think about it from the bank’s perspective.
Let’s pretend that you and your next door neighbor have a similar levels of income and very similar home values. We’ll use $400,000 for this example. Let’s also say both lost your jobs at the same time, maybe during another sever recession. And, let’s say that both of you were out of work for an extended period of time during which you both had to live off of savings just to get by and make ends meet.
Included in your monthly expenses would be your mortgage, of course. And with limited or no income, after a while you both start falling behind in your mortgage payment.
The bank is now in a position where they need to clean up their balance sheet, so they start looking at which homes they may need to foreclose on to cover some of their outstanding loans. Since you and your neighbor are both behind in your payments, they look at which one of you to foreclose on first. Are you tracking with me so far?
You have done a great job of paying down your mortgage, maybe with a 15 year loan, and you only owe around $100,000 on your loan. Your neighbor refinanced his mortgage a few times, pulled cash out, and did a regular 30-year loan, so that his loan balance is closer to $320,000. Both of your homes are worth roughly the same, but you have a lot more home equity than your neighbor. You think of it as an asset, but just to keep reshaping your thinking here, let’s see if it really is.
Let’s pretend now that you are the banker looking to cover your loans. Which of the two houses would you foreclose on first, yours with a loan balance of $100,000 or your neighbor’s loan of $320,000? Think about it.
What is the bank trying to do during a foreclosure? Cover their loan, right?
And in which scenario will the bank have an easier time covering their loan, by selling your house or by selling your neighbor’s house? What will they have to sell yours for to cover your loan? Only $100,000, right? And will they do it? Of course they will. Yours is worth a lot more than that. But, what just happened to all of your home equity? That asset you were counting… It could be gone in a flash. And the bank doesn’t care about it because all they wanted to do was cover their loan.
Going back to your neighbor’s house, how much do they have to sell it for to break even? At least $320,000, right? Do you think the mortgage company will be more patient with your neighbor than they will be with you when it comes to the foreclosure process? You bet they will. They will need to work much harder to break even on that loan, so the borrow will get a lot more time to figure something out.
Seeing the truth Do you see where this is going? All this time you thought the equity in your home was an asset, and in a way you were right – it just wasn’t an asset on your balance sheet. It was an asset on the bank’s balance sheet because they know that from time to time the economy will cycle down and they don’t want to have all of their loans out to people will very little equity in their homes. They have to cover themselves, which is why they are willing to give up collecting more interest on a 15 year mortgage in exchange for the flexibility it provides in covering that loan faster should they ever need to in the future.
I bet you’ve never thought of it that way, but like I’ve said before, if something you always believed to be true turned out not to be true, when would you want to know about it?
Let me say this in closing. I firmly believe that being in a position to pay off your mortgage is essential in a well-designed financial plan, but that doesn’t mean that actually committing all of that cash to pay it off will get the best results. Enjoy your home but make the money you’ve invested into it work for you.
I know I’ve covered a lot here today and you’ll likely need the guidance of a skilled CERTIFIED FINANCIAL PLANNER™ professional to walk you through the specifics of this strategy and help you properly set up the right kind of side account. Today’s topic is in there plus a lot more that you’ve probably never been told, but definitely need to hear.
What do you think? Has anybody ever shared this kind of information with you in this way before? I’m guessing the answer is no. And why is that? These are the kind of questions you have to ask yourself when you’re learning how to protect your best interest and use your resources wisely, both in planning for college and in planning for the rest of your life.
High school counselors, your friends and family, investment managers and brokers, accountants, attorneys, and even many college advisors don’t understand how to build a comprehensive plan that allows you to be better off financially after paying for college the yard today. That’s the benefit a College Planning Specialist can offer you. And, if you have kids going to college in the next few years, let me encourage you to get the help of a true College Planning Specialist to help improve your chances of success. You can request a free review of your college game plan and set up a time when we can talk together about where you are and what you’re trying to go with your family’s college plan. It’s free and no one has ever done it is that it was a waste of their time.
One of the best ways to improve your results when planning for your children’s education is to also increase your education on how to beat the colleges at their own game. Like I’ve talked about today, sometimes some of the solutions don’t involve college directly, but they definitely tie in to the bigger picture. You’re getting a good financial education by reading these articles and I hope you’ll subscribe, share us with your friends, and join me back her again soon.