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Equity Management Is Overrated

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Equity Management


A few years ago, in the middle of the housing boom, I came across the equity management philosophy of wealth creation. The basic premise is that in order to maximize your wealth over the long term you should not pay off your mortgage. Instead you should leverage the mortgage debt to create wealth. Debt leveraging is where you borrower as much as you can against your house and only pay the interest only portion of the loan.  The idea being that you invest the portion you would have paid towards principle and obtain a return.During the housing boom this seemed to make sense, and I know several people who ended up doing exactly that. They cashed out on their homes on interest only mortgages and invested it in the market. I know many who used life insurance vehicles to “maximize” their long term wealth building power. The use of life insurance vehicles is a whole different article all together and I don’t have very kind words for that strategy either.

Advocates insist there are many reasons to follow this equity management strategy. The first is to put to work the asset (equity) trapped in your house. The second is to take advantage of the tax deduction as much as possible. And so on and so forth. There is an entire Brother A and Brother B example used that demonstrates the advantages.

Within our industry anyone who does not believe in equity management strategy is considered a dinosaur. The thinking is that equity management is the wave of the future and takes into consideration the evolved mortgage landscape. As a mortgage professional I have never felt comfortable with equity management. The enthusiasm that I hear about equity management reminds me of the “new economy” arguments of the late 1990s.

Here are my reasons for not fully believing in equity management:

  1. What happens if you mortgage yourself to the hilt and then the real estate market crashes? Oh wait that may have just happened to a few folks. Add in the fact that the stock market is flat and the cash you dumped into the life insurance vehicle just got chewed up to pay for their fees, leaving you with no cash value. But wait it’s a long term strategy, say proponents – but to quote John Maynard Keynes “in the long run we’re all dead.”

  2. I’ve read surveys which show that a major event happens in a person’s life every three to four years. This major event could be the birth of a new child, job changes (hired or fired), marriage etc. etc. This event normally causes a major readjustment to a persons financial needs. Now if you’re trapped in a 100% interest only mortgage within a flat real estate market, things don’t look too rosy, do they? Will your steady investment have made enough money to compensate for the cash you need to switch homes? A very fair question to ask in my opinion.
  3. It has also been found that people do not stay in a mortgage for more than four years and in a house for more than seven years. The best way to ensure your mobility is equity in your home. This is a similar point to the one I just made above.
  4. Finally, this strategy simply doesn’t work for folks on tight budgets, erratic spending patterns, those with credit card debt etc. It only works for the marginally wealthy with great financial self discipline. Also for those who know what their employment situation will be in five years, who live on a budget, have a comfortable cash reserve and who expect their incomes to rise steadily with time.

Bottom line, the equity management strategy assumes a long term hold of the same real estate with steady long term investment gains. It’s not so bad, if these two aspects were not so completely related together, with one greatly affecting the other. Also, I have found that life is not nearly as stable and predictable as you’d like. You may have to move because your mother needs you closer due to her failing health. Your child may decide to attend an out of state college. Simply put, life happens and equity in your house makes it easier to deal with unforeseen circumstances.

At the personal level the main reason I have a difficult time with equity management is because I can’t turn my primary residence into an investment vehicle. I can’t play dice with the roof over my child’s head. Call me chicken. Go ahead. I don’t know why but I just can’t. I am confident that I can build wealth through other means, but not by leveraging the one assest that is the foundation for every other goal in my life!

Maybe it’s a cultural thing. I am from a fairly conservative background and was taught to pay off all debt and not to owe anybody anything. It may not seem like good advice now, but it’s a time tested principle. Just think of how much less of a problem this credit crunch would have been had people simply bought what they could afford and tried to build some equity in their homes. It would have been a storm in a tea cup and not a tsunami that has chocked the life out of the global economy! In fact the whole thing would have never happened.

Writer for national real estate opinion column AgentGenius.com, focusing on the improvement of the real estate industry by educating peers about technology, real estate legislation, ethics, practices and brokerage with the end result being that consumers have a better experience.

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9 Comments

9 Comments

  1. Benjamin Bach

    February 13, 2008 at 2:03 pm

    Shailesh, I think what it comes down to is educating yourself about all the investments you’re making.
    Taking underperforming equity out of a home to invest in a positive leverage situation can create massive returns for an investor – and if they aren’t careful, losses.

    As Buffett says, education mitigates risk. My clients are educated, and do very well using home equity to invest in appreciating assets.

    BenjaminBach.com

  2. Robert D. Ashby

    February 13, 2008 at 3:57 pm

    I agree with what Benjamin stated and I have yet to have anyone who is educated tell me that it is overrated, rather they say the word needs to get out about what it equity management truly is.

    Equity Management goes beyond simply taking cash out and investing, it is incorporating your home’s equity into your overall financial and investment plans. I am a conservative guy as well and would not “bet my house” either. Equity Management keeps you from “betting”, but rather balancing to provide a better chance of attaining financial goals.

  3. Shailesh Ghimire

    February 13, 2008 at 4:57 pm

    Benjamin and Robert,

    Great points. It is all about education and making sure it makes sense. However, my nervousness has to do with placing your house on the line. On paper whole thing makes sense, but with the way things can change overnight, it’s too risky and for most people it makes little sense. I’m fearful of the guys who have been calling me up wanting me to send them my borrowers so they can do a life insurance product for them with all their home equity. Sounds like a guy with a hammer that sees everything as nails.

    Education, assessment, understanding risk and your personal risk level is what it’s all about. When it comes to investments, I firmly believe you have to play both offence and defense. Playing offence with your home when your home should be a surefire defense, that is what bothers me the most.

    Thanks for your comments guys!

  4. Benjamin Bach

    February 13, 2008 at 8:45 pm

    If you only play defence, you’ll never score a goal. You need a good defence, and a good offence.

  5. Brian Brady

    February 14, 2008 at 9:09 pm

    Shailesh,

    Equity management, as a name, may be “new”, the principle is not. I’ve practiced it since 1990 and it’s served me well. I have a leveraged home and enough cash to pay off the mortgage with a click of the mouse and a 3 day wait.

    I think the problem is that we have unsophisticated originators talking to unsophisticated customers about a strategy that is a little more complicated than the brother a vs. brother b demonstration.

    However, when properly implemented by a mortgage originator, a stockbroker, a CPA, and an insurance agent, any argument against the strategy (no matter what you call it) is defeated. I’ve heard critics claim that the strategy doesn’t work in a depression; trust me- neither does owning real estate, regardless of the mortgage

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Economic News

Is the real estate industry endorsing Carson’s nomination to HUD?

(BUSINESS NEWS) Ben Carson’s initial appointment to HUD was controversial given his lack of experience in housing, but what is the pulse now?

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NAR strongly backs Dr. Carson’s nomination

When President-Elect Donald Trump put forth Dr. Ben Carson’s name as the nominee for Secretary of Housing and Urban Development, NAR President William E. Brown said, “While we’ve made great strides in recent years, far more can be done to put the dream of homeownership in reach for more Americans.”

At the time of nomination, the National Association of Realtors (the largest trade organization in the nation) offered a positive tone regarding Dr. Carson and said the industry looks forward to working with him. But does that hold true today?

The confirmation hearings yesterday were far less controversial than one would expect, especially in light of how many initially reacted to his nomination. Given his lack of experience in housing, questions seemed to often center around protecting the LGBT community and veterans, both of which he pledged to support.

In fact, Dr. Carson said the Fair Housing Act is “one of the best pieces of legislation we’ve ever had in this country,” promising to issue a “world-class plan” for housing upon his confirmation…

>>>>>Click to continue reading…<<<<<

#CarsonHUD

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Job openings hit 14-year high, signaling economic improvement

The volume of job openings is improving, but not across all industries. The overall economy is improving, but not evenly across all career paths.

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Job openings hit a high point

To understand the overall business climate, the U.S. Labor Department studies employment, today releasing data specific to job vacancies. According to the department’s Job Openings and Labor Turnover Survey (JOLT) for April, job openings rose to 5.38 million, the highest seen since December 2000, and a significant jump from March’s 5.11 million vacancies. Although a lagging indicator, it shows strength in the labor market.

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The Labor Department reports that the number of hires in April fell to 5 million, which indicates a weak point in the strong report, and although the volume remains near recent highs, this indicates a talent gap and highlights the number of people who have left the labor market and given up on looking for a job.

Good news, bad news, depending on your profession

That said, another recent Department report notes that employers added 221,000 jobs in April and 280,000 in May, but the additions are not evenly spread across industries. Construction jobs rose in April, but dipped in professional and business services, hospitality, trade, and transportation utilities. In other words, white collar jobs are down, blue collar jobs are up, which is good or bad news depending on your profession.

Additionally, the volume of people quitting their jobs was 2.7 million in April compared to the seven-year high of 2.8 million in March. Economists follow this number as a metric for gauging employee confidence in finding their next job.

What’s next

If you’re in the market for a job, there are an increasing number of openings, so your chance of getting hired is improving, but there is a caveat – not all industries are enjoying improvement.

If you’re hiring talent, you’ll still get endless resumes, but there appears to be a growing talent gap for non-labor jobs, so you’re not alone in struggling to find the right candidate.

Economists suspect the jobs market will continue to improve as a whole, but this data does not pertain to every industry.

#JobOpenings

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Economic News

Gas prices are down, so are gas taxes about to go up?

Do low gas prices mean higher gas taxes are on the way? Budgeting for 2015 just got a bit more complicated, if some politicians have their way.

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gas tax

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Gas taxes and your bottom line

Many industries rely heavily on time in their vehicle, not just truck drivers and delivery trucks. Sales professionals hop in their vehicles throughout the day, as do many other types of professionals (service providers like plumbers, and so forth). For that reason, gas prices and taxes are a relevant line item that must be budgeted for 2015, but with politicians making the rounds to push for higher gas taxes, budgeting becomes more complicated.

Gas prices are down roughly 50 cents per gallon compared to a year ago, which some analysts say have contributed to more money in consumers’ pockets. Some believe that this will improve holiday sales, but others believe the timing is just right to increase federal taxes on gas. The current tax on gas is 18.40 cents per gallon, and on diesel are 24.40 cents per gallon.

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Supporters and opponents are polar opposites

Supporters argue as follows: gas prices are low, so it won’t hurt to increase federal gas taxes, in fact, those funds must go toward improving our infrastructure, which in the long run, saves Americans money because smoother roads mean better gas mileage and less congestion.

Gas taxes have long been a polarizing concept, and despite lowered gas prices, the controversial nature of the taxes have not diminished.

While some are pushing for complete abolition of federal gas taxes, others, like former Pennsylvania Governor, Ed Rendell (D) tell CNBC, “Say that cost the average driver $130 a year. They would get a return on that investment” in safer roads and increased quality of life, he added.

The Washington Post‘s Chris Mooney points out that federal gas taxes have been “stuck” at 18 cents for over 20 years, last raised when gas was barely a dollar a gallon and that the tax must increase not only to improve the infrastructure, but to “green” our behavior, and help our nation find tax reform compromise.

Is a gas tax politically plausible?

Mooney writes, “So, this is not an argument that a gas tax raise is politically plausible — any more than a economically efficient tax on carbon would be. It’s merely a suggestion that — ignoring politics — it might be a pretty good idea.”

Rendell noted, “The World Economic Forum, 10 years ago, rated us the best infrastructure in the world,” adding that we “need to do something for our infrastructure, not in a one or two year period, but over a decade.”

Others would note that this rating has not crumbled in just a few years, that despite many bridges and roads in need of repair, our infrastructure is still superior to even the most civilized nations.

Regardless of the reasons, most believe that Congress won’t touch this issue with a ten-foot pole, especially leading up to another Presidential campaign season starting next year.

“I think it’s too toxic and continues to be too toxic,” Steve LaTourette (the former Republican congressman best known for his close friendship with his fellow Ohioan, Speaker John Boehner) tells The Atlantic. “I see no political will to get this done.”

Whether the time is fortuitous or not, and regardless of the positive side effects, many point to a fear of voters’ retaliation against any politician siding with a gas hike, so this matter going any further than the proposal stage is unlikely.

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