Advice....Should I look at home equity this way?

[HFWR]

Since appreciation on my house has averaged around 2.5%, I don't consider it much of an "investment. Plus, if I sell, I'll need to do some fixin', and pay the realtor...

Might have a different opinion with 10% appreciation...

I've probably not seen ANY actual appreciation, given the two plumbing catastrophes, the new A/C unit, the constant struggle to keep a lawn and what passes for landscaping alive, killing termites and fireants, patching roof leaks, replacing and repairing faucets and toilets, applying bandaids to my aging and ailing sprinkler system...

A lot o' work and expense, though luckily? I can do most of the maintenance and repairs myself...

I do like having a garage, and enjoy the privacy!

 

[Gone4Good]

You can always sell and downsize or sell and rent, so its a fairly liquid asset as well.

So the theory is that I can hold more equities in my portfolio because I have home equity that can be monetized, if needed, to provide the stability I'd ordinarily look for in a bond portfolio?

So when the economy is in the crapper and my equities are tanking I'm supposed to sell my house and rent? I imagine I'll get top dollar on that trade. Sure, I could borrow against it, but lenders typically look askance at non-working folks of diminishing net worth trying to borrow against what is likely a depreciating asset (given the economic assumption referenced earlier). And payments on the borrowed money increase your withdrawal rate at the very time you should be reducing it.

Even if that scenario made sense, you'd have to go into this asset allocation scheme with the full knowledge that your withdrawal strategy anticipates you selling your home and moving. Most people construct portfolios so that they can avoid being forced from their homes.

 

[cute fuzzy bunny]

Seems that you've interpreted everything I said as far foolish as possible and shoved a bunch of words in my mouth. Give me a break.

Save me a little time too...re-read what I said and then try to explain to me how you came up with this stuff.

 

[Gone4Good]

Absolutely the home is part of your "bond" holdings, at least thats the way I look at it. People hold bonds to provide stability and income in their portfolio. Living in a paid off house removes much of the need for stability and income in your portfolio.

You can always sell and downsize or sell and rent, so its a fairly liquid asset as well.

The whole 800k acts exactly like a "bond" with regards to your investing decisions, IMO.

So I interpreted the preceding quote as follows:

So the theory is that I can hold more equities in my portfolio because I have home equity that can be monetized, if needed, to provide the stability I'd ordinarily look for in a bond portfolio?

Still seems like a fair interpretation.

You may disagree with what I consider to be the logical implications of using your house as a bond (i.e. potentially having to monetize it), but I don't think I put words in your mouth.

I'm also a bit curious how you rebalance your portfolio. Build a deck when times are good, sell a bedroom on the downturn.

A house is not a bond and I think it is a mistake to structure a portfolio assuming it is.

 

[rs0460a]

Sometimes a house is just a home.

Agreed!!! Anything more than that is just "what if's?" in the financial sense.

• What if I sell it
• What if I keep it
• What if I do a reverse mortgage
• What if I bequeath it to the next generation
• What if...

Remove the "what if's" and substute an "action". Until you do, it dosen't matter what your "plan" is, or how you view the "value" of a house. Plans change...

Anyway, a house, viewed as a "home" is more than that (it's priceless )

- Ron

 

[sgeeeee]

Here is my 2 cents:

House equity is not a bond

That said, I believe house equity will allow you to significantly increase your equities allocation if you meet all the following conditions:


1) You have a fairly secure job or source of income to meet expenses.

2) You plan to sell the house and downsize to less expensive house in the future.

3) You are confident that the market value of your house will remain stable or increase from now until you plan to downsize.

4) You plan to allocate the liquid equity into real FI instruments after you sell the house and move/downsize into the cheaper house.

5) Your house is mortgage free (preferred but optional, depending on your personal sleep at night comfort level)

Note that these "conditions" represent risk that does not correspond to bond risks. Thus, a house represents an investment with a different risk-reward profile than a bond. Since the risk-reward relationship is the underlying principle that values all investments, the two are fundamentally very different and the differences should be understood.

A bond is a loan. Real estate is more like a business than a loan. With a bond an investor is loaning funds at a fixed rate and the entire principal is repaid at bond maturity. With real estate, both principle and income of the investment is subject to change based on market forces. There is no maturity date. Property owners also have to manage, repair, pay taxes, and insure their investment. Bonds are entirely passive investments.

 

[cute fuzzy bunny]

Still seems like a fair interpretation.

You may disagree with what I consider to be the logical implications of using your house as a bond (i.e. potentially having to monetize it), but I don't think I put words in your mouth.

I'm also a bit curious how you rebalance your portfolio. Build a deck when times are good, sell a bedroom on the downturn.

A house is not a bond and I think it is a mistake to structure a portfolio assuming it is.

You picked some piece parts of what I said and created some implications. It seems you missed the part where I thoroughly explained the role the home equity plays in my financial planning. Nowhere did I say I planned to liquidate the property, just that it was an option. Nor do I see any reason to imply that liquidation is necessary or even suggested.

But do continue to ridicule what you apparently didnt read thoroughly enough to fully comprehend. The OP got what he needed and seems to have understood my input with no problems.

 

[kumquat]

This may be a contrarian view. DW and I own our house mortgage free. We also own a bit of farm land (nearby, mortgage free and rented to BIL) and a condo in a hot market 500 miles away (DW lives in the mortgaged condo).

While both farm & condo rent for enough to handle expenses, we don't consider them (house, condo,farm) part of our assets when calculating a SWR since the return is near 0 and we are unlikely to sell them unless really destitute. Call us stupid but that's the way it is, at least for now.

Owning the house does lower our projected expenses though and we consider that.

Our view is that you have income producing assets and other assets making up your net worth. Only the income producing matter for RE income purposes. Would you RE with 10M in jewelry but no income?

 

[jdw_fire]

Let me give an example to try and throw some light on the house is a bond arguement. For this example I will examine two households that have equal house values ($250k), equal net worths ($1050K) and equal lifestyles.

Household A has a 30 yr mortgage on their house of $200k @6% with P&I of $1193/mo and a portfolio of $1M from which they are taking a 4% SWR giving them $40K to cover all their expenses. Now it takes $14316 of the $40K to pay the P&I on the mortgage leaving them with $25684 for all their other expenses.

Household B does not have a mortgage on their house but only has an $800K portfolio. Now since their lifestyle is equal to Household A they only need $25684/yr for their expenses (plus worstcase $1779 for the additional tax bite due to not having an interest deduction) which is a SWR of 3.21% (or 3.43% with the extra for taxes). The question now is when running FIRECalc and you change the portfolio mix between (keeping the portfolio simple) stocks and bonds, raising the bond %age will lower the SWR thus the paid off house acts like a bond.

Note: I think another point CFB makes is that since Household B only needs a SWR that is lower than Household A they can choose to do either of two things in their portfolio 1) take on more portfolio risk than B by investing a greater %age of their portfolio in stocks or 2) go for a safer but lower yielding portfolio than B by investing a greater %age of their portfolio in bonds, where neither of these choices will be more risky to their lifestyle.

 

[wabmester]

Household A has a 30 yr mortgage on their house of $200k @6% with P&I of $1193/mo and a portfolio of $1M from which they are taking a 4% SWR giving them $40K to cover all their expenses. Now it takes $14316 of the $40K to pay the P&I on the mortgage leaving them with $25684 for all their other expenses.

I think most people would agree that the principal payment of the P&I is savings rather than an expense. You're paying yourself and saving the money as home equity.

It'd be nice if FC had a built-in amortization calc for the mortgage case, but if you're half-way through a mortgage, the split becomes about $500 principal and $700 interest, which gives you an SWR of 3.4% for the mortgage case (not considering the tax break).

 

[sgeeeee]

Let me give an example to try and throw some light on the house is a bond arguement. For this example I will examine two households that have equal house values ($250k), equal net worths ($1050K) and equal lifestyles.

Household A has a 30 yr mortgage on their house of $200k @6% with P&I of $1193/mo and a portfolio of $1M from which they are taking a 4% SWR giving them $40K to cover all their expenses. Now it takes $14316 of the $40K to pay the P&I on the mortgage leaving them with $25684 for all their other expenses.

Household B does not have a mortgage on their house but only has an $800K portfolio. Now since their lifestyle is equal to Household A they only need $25684/yr for their expenses (plus worstcase $1779 for the additional tax bite due to not having an interest deduction) which is a SWR of 3.21% (or 3.43% with the extra for taxes). The question now is when running FIRECalc and you change the portfolio mix between (keeping the portfolio simple) stocks and bonds, raising the bond %age will lower the SWR thus the paid off house acts like a bond.

Note: I think another point CFB makes is that since Household B only needs a SWR that is lower than Household A they can choose to do either of two things in their portfolio 1) take on more portfolio risk than B by investing a greater %age of their portfolio in stocks or 2) go for a safer but lower yielding portfolio than B by investing a greater %age of their portfolio in bonds, where neither of these choices will be more risky to their lifestyle.

I ran these simulations back in the archives somewhere. Even if you treat your house as a bond (a very unjustified assumption) readjustment of the equity/bond allocation doesn not eliminate the historical advantage of keeping a mortgage for low enough interest loans and long enough time periods. In other circumstances, with higher interest rates, paying off the loan would have been advantageous.

If you payoff your mortgage, you have x% equity, y% bond, and z% home. Each of those assets is different with different risks and different potential for reward. If you keep your mortgage you have (x+delx)% equity, (y+dely)% bond, s$ home, and t% mortgage debt. Each of these assets is different with different risks and different potential reward. Owning a home is not without risk. Not all risk can be simply quantified using beta or other metrics that measure only market risk. Inflation risk, longevity risk, opportunity risk, etc. are not easily quantified and are different for each of the asset classes. In the case of a house, the risks are unique to the particular house and location you are in. Each investor has their own risk comfort level and depending on their situation some investors may have less longevity risk but more inflation risk(because of a significant pension, for example) than another.

So . . . the decision to payoff or keep a mortgage is a risk-reward decision. The risk portion of the equation is unique to each house and each investor. The only person who is wrong in these debates is the person who believes that a "one size fits all" decision is appropriate. Every case is different and only be evaluating your personal situation can you find the answer that is best for your house and your risk tolerance. Assuming a house to be the same as a bond neglects the fundamental risk-reward consideration that is the basis for all investment valuations. The "best" answer for you may be the same with or without this assumption, but it won't be like that for everyone.

 

[jdw_fire]

I think most people would agree that the principal payment of the P&I is savings rather than an expense. You're paying yourself and saving the money as home equity.

It'd be nice if FC had a built-in amortization calc for the mortgage case, but if you're half-way through a mortgage, the split becomes about $500 principal and $700 interest, which gives you an SWR of 3.4% for the mortgage case (not considering the tax break).

Whether you consider the principle payment part of your P&I savings or not doesn't matter to my example as my example addresses cash flows. Since the two households in my example are retired they both require a certain level of cash flow from their portfolios to maintan their lifestyles. Even though part of that cash flow for Household A goes to a monthly principle payment it is still a required part of their WD so it counts toward their WD rate.

So . . . the decision to payoff or keep a mortgage is a risk-reward decision.

I posted my example to show how a mortgage free house could be viewed as a bond in someone's portfolio not to make an argument for paying off a mortgage, which is a different topic.

 

[wabmester]

I guess your example just shows that not all cash flow is the same. If part of it flows back to me, do I really care if the withdrawal rate increases in the process? That type of flow is something you can always shutdown if it makes you nervous, but it seems very convoluted to let that equity build-up impact on the withdrawal rate change your investment criteria.

 

[sgeeeee]

. . .
I posted my example to show how a mortgage free house could be viewed as a bond in someone's portfolio not to make an argument for paying off a mortgage, which is a different topic.

But if you view it that way, you shift the risk-reward balance of your portfolio in a way that does not recognize the distinction between a bond and a house. I included the mortgage aspect only because your example did.

 

[cute fuzzy bunny]

The question now is when running FIRECalc and you change the portfolio mix between (keeping the portfolio simple) stocks and bonds, raising the bond %age will lower the SWR thus the paid off house acts like a bond.

Note: I think another point CFB makes is that since Household B only needs a SWR that is lower than Household A they can choose to do either of two things in their portfolio 1) take on more portfolio risk than B by investing a greater %age of their portfolio in stocks or 2) go for a safer but lower yielding portfolio than B by investing a greater %age of their portfolio in bonds, where neither of these choices will be more risky to their lifestyle.

Ding! Ding! Ding!

I see the problems. Everybodys stuck on the "HOUSE ISNT A BOND!!!!!" thing.

Its not a bond. Okay?

Now that we're past that hairball, can we move on from that to "HOME EQUITY CAN PERFORM A SIMILAR FUNCTION TO A BOND IN A PORTFOLIO"?

What you're doing in effect is removing a huge monthly cost which enables you to employ more flexibility in your portfolio...exactly as JDW describes.

In fact, you're foolproofing your retirement. In a "normal" scenario, should we have one of the two big failure situations - the depression and the 65-75 sideways period - you would be progressively eating your equities to pay the mortgage or have to go back to work to pay the mortgage.

In the other scenario without a mortgage payment, you could cut spending a bit, get by on dividends, worst case a part time job mowing laws, and leave your portfolio intact to bounce back once you're past the bear market.

Nowhere would I incorporate selling the house as part of a reasonable plan.

Setting aside the quackery around "rebalancing" by adding a porch or hacksawing off a room :, one can fine tune by adding or removing small amounts of bonds in addition to their home equity and stocks for diversification purposes.

I ran these simulations back in the archives somewhere. Even if you treat your house as a bond (a very unjustified assumption) readjustment of the equity/bond allocation doesn not eliminate the historical advantage of keeping a mortgage for low enough interest loans and long enough time periods. In other circumstances, with higher interest rates, paying off the loan would have been advantageous.

Absolutely true. If you have a mortgage at about 5%, its a toss up. Once you pass below 4%, hell...I'd get a mortgage. In fact, when I had a shot at a 3.96% five year fixed in 2002, all y'all told me not to get it and invest the proceeds in stocks. Some prognosticators you guys turned out to be!

At the current rates and historical normal rates, the firecalc runs we tortured endlessly over the months and years established:

At mortgage rates of 5%+, by paying off your mortgage and reducing your bond holdings to move from a 50/50 or 60/40 to a 70/30 or 80/20, that you would make more money, have a higher SWR, a higher average terminal portfolio size and a higher survival percentage.

In other words, you could retire earlier, on less money, and have a better chance (against historical data) of "making it". Now come on, lets line up to find the "problem" in this opportunity...

In that scenario, the role of bonds is limited or non-existant. You simply dont need them, but are obviously most welcome to continue to hold some as a diversifier.

OF COURSE there are exceptions to this and lots of parameters. You need to run the numbers for yourself. Taxes are a big deal. In my personal scenario, by getting rid of the big withdrawal, the big payment, and tweaking a few other things, I end up paying almost nothing in income taxes.

I think a linchpin to it is looking at what percentage of your spending you could eliminate, and what percentage of your portfolio would be taken away to remove the home debt.

If your mortgage payment is 30-40% of your spending in retirement, and your portfolio would be reduced by 10-20% by paying off the mortgage...I'm betting you have a winner. If the mortgage is 20% of your spending and you'd cut your portfolio in half by paying the mortgage off...thats probably not going to be a good scenario.

In my case, I cut my spending by 35% and "suffered" a 15% drop in my portfolio. Went from a 50/50 to an ~80/20. My firecalc numbers went WAY up.

And I can tap that reserve at any time by writing a check on my free home equity line of credit. So much for the complications of liquidity... :

You are absolutely missing out on a huge thing if you dont run this calc and consider it. Of course, there are people who refuse to include their home in any planning, including net worth. If you have that hairball, just move along. Nothing to see here...

 

[rs0460a]

Nothing to see here...

Agreed...

- Ron

 

[cute fuzzy bunny]

About the same value as your contributions to the forum, which appear to be roughly 30% unwarranted snipes and the remainder largely unhelpful or unpleasant remarks.

 

[wabmester]

Ugh, this appears to be a hairball derivative of the pay-off-your-mortgage debate. I don't want to go there, and I can understand people wanting to pay off their mortgage to reduce debt, reduce cash flow, etc. But just for fun, I'll reiterate that not all cash flow is the same.

When you have a mortgage, that cash flow has the following characteristics:

1) The payments go down in real terms. Unlike everything else in your budget, mortgage payments don't go up with inflation.

2) They are fixed term, so relatively easy to plan for, and they go away on their own.

3) They are a form of forced savings. Part of the payment comes back to you as home equity.

4) Another part comes back to you in the form of reduced taxes (for most people).

5) As long as your investment returns exceed your interest rate, you can successfully use the mortgage to leverage your investment returns.

 

[cute fuzzy bunny]

Of course its the mortgage discussion...where else would a question regarding "does my home equity affect my portfolio" end up?

Your points are good for an accumulator saving for retirement. What I proposed was a different way of looking at it where your points 2, 3, 4, and 5 are rendered inapplicable or moot.

#1 is often a red herring because people on average dont stay in a home/loan long enough to let inflation help them very much vs the interest paid since thats heavy on the front end.

On #4, my scenario produces lower taxes than if I had a mortgage and the related higher withdrawals. Our net income after standard deductions lands us well within the lowest brackets for income and capital gains. If I added a mortgage and another 25-35k in withdrawals, all of that would be at 15% income/capital gains rates or higher. I'd have to go back to my tax returns from this year for the exact number, but my overall federal tax rate was around 3.5%.

On #5, you must have missed the part about being able to 'slide' your asset allocation towards a higher equity component to produce higher rates of return.

Everything you do financially affects a lot of other things. Many people like to 'fishbowl' piece parts of it to make wrapping their brains around it easier. Unfortunately that may lead some to make a set of good fishbowl decisions that cost them money overall.

 

[laurence]

Whenever these debates start, I feel like Lord Farquaad in Shrek trying to pick a princess "Pick numba 3 m'lord!".

I've said before our choice was a cop out of a 20 year @ 5% and be mortgage free at retirement. I will be keeping leaning more towards equities in retirement than some of my compatriots (heck, I'll probably cop out and just go Wellington).

I have a specific question for the triad of power here ( CFB, WAB and Sgeee): is there consensus that having a 6% mortgage while having significant money in a 4% fixed return asset (say, a bond, or CDs or whatever) does not make sense? I think where most lurkers can gain value is by understanding where they are shooting themselves in the foot with their asset allocation vs. mortgage decisions.

 

[cute fuzzy bunny]

I personally see very little reason in an accumulator keeping a 6% mortgage and a bunch of 4% bonds.

I'm tempted to remove the word 'accumulator' from the above comment.

While "4% bonds" also can return significant capital gains along with the interest...I dont think the near term is going to be one of those times.

The problem with these diatribes is that you have some folks who think they're being 'tricked' if you include more than 2 variables, and the 'major players' have already done their analysis, made their decisions, and are now in the position of defending that decision. And occasionally taking it personally.

The reality is that the number of variables makes issuing any blanket statements impossible.

That having been said, I find very few good arguments for a retired person without an income, living off their portfolio, to keep a mortgage...unless they own few/no bonds or significant cash reserves or have some odd tax situation where they'd be itemizing with or without mortgage interest.

 

[wabmester]

is there consensus that having a 6% mortgage while having significant money in a 4% fixed return asset (say, a bond, or CDs or whatever) does not make sense?

As a general practice, I would pay off high-interest debt before putting new money into a low-interest FI investment, and I'm pretty sure there's consensus on that.

When the decision is closer to break-even, say a 5% mortgage and a 5% short-term CD or money market, I would keep the long-term debt and invest in the short-term FI. If rates drop in the future, you can always reevaluate. If rates go up, then your long-term low-interest debt is golden!

 

[Nords]

When the decision is closer to break-even, say a 5% mortgage and a 5% short-term CD or money market, I would keep the long-term debt and invest in the short-term FI. If rates drop in the future, you can always reevaluate. If rates go up, then your long-term low-interest debt is golden!

Waitwaitwait, I have some good ones--

What if you move more often than every seven years and paid closing costs on both ends?

What if you paid points or "origination fees" on the mortgage?

What if your annual mortgage interest doesn't exceed the amount of the standard deduction by at least 50%?

What if it's a 15-year or 40-year mortgage instead of 30 years?

What if only small-cap value stocks still have an equity risk premium or you invested in dividend-payers instead of growth stocks?

What if I bonds go above 1.5% fixed?

What if the tax laws change again?

What if a giant meteor... oh, wait, different post.

I think everyone is beginning to appreciate why there's as many opinions right answers for everyone as there are asshoposters.

 

[cute fuzzy bunny]

Who you calling an asshoposter?

Do they have to wear diapers when driving long distances?

 

[Gone4Good]

Liquidity is under appreciated in most of these "a house acts like a bond" discussions.

First lets stipulate that a higher equity allocation leads to higher portfolio survivability, up to a point. Although, in most cases going beyond 80% results in diminishing returns for someone relying 100% on his portfolio.

Lets also stipulate that if it makes someone feel more comfortable to look at their home value as a source of stability, which in turn allows them to increase their equity allocation from 40-50% to 60-70%, its probably a good trade off. But I seriously question the value, or the wisdom, of someone increasing their equity allocation to 90-100% because their house "acts like a bond." It doesn't.

Rebalancing is an important risk mitigant in portfolio survivability. Drawing on a bond portfolio to avoid selling and also to replenish a declining equity portfolio is important to portfolio survivability. That is why an 80% equity portfolio generally has greater survivability than a 100% equity portfolio. Sure you can draw on a home equity line to provide short-term liquidity, but such lines are far more costly then the lost income from selling a bond. Current HELOCs are averaging between 7%-8% and then need to be repaid monthly - hardly optimal, or even desirable. Further, I sure wouldn't want to have relied on a floating interest line of credit for liquidity and rebalancing during the 70's - yikes. If you're truly rebalancing, it also puts you in a position of having to borrow on the house to buy stocks . . . not for me, or most people, I think.

The caveat that "you can hold bonds for rebalancing" gives the lie to the notion that your home equity is a bond equivalent.

Bonds also provide income, which reduces the need to sell anything - possibly as low as 0!

I hope you also mark-to-market your house when doing this calculation. Real-estate isn't necessarily as stable as everyone currently hopes/expects - even in squiggly states. Average nominal housing prices in LA, for example, declined 20% from 1990 to 1996 and took 10 years to recover their peak. Similarly, a colleague of mine bought a condo in NYC in the early 80's and could not sell it for almost 10 years. Hardly a source of liquidity or stability . . . more like a financial anchor.