Missed Fortune 101 — Horrible Advice part 2
August 1st, 2005 | by mbhunter |If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!
I promised some more discussion about Douglas Andrew’s Missed Fortune 101 — which is not really an investment book as much as it is a plug for lenders and insurance companies. In this post I’ll talk about some of the points he brings up against paying down your mortgage faster.
The main idea of the book, in a nutshell, is to “manage your home’s equity” by periodically pulling out more and more cash by taking out loans against the equity in your home, and investing the proceeds in life insurance vehicles in an arbitrage play. To this end, he sets the stage for this investment scheme by giving you reasons for not paying down your mortgage. These reasons are misleading and false.
On page 101, he claims that “[m]ortgage interest if your friend, not your foe.” Well, let’s see why this is, shall we? If you accelerate mortgage payments by reducing the term, or making extra payments, etc., you risk all kinds of things, according to Mr. Andrew. I’ll discuss each of the six bullet points he makes on page 130 in detail.
Losing control of your home equity
Well, you can’t spend the equity any time you want, maybe, but you could tap into it if you needed to. You don’t “lose control” of it just because it’s untapped. Originating a “pre-emptive” HELOC doesn’t seem to make much sense. You may stand more of a chance of losing control of it if you incur debts that you can’t pay back or get into investments that are illiquid or lose money.
Increasing the after-tax cost of owning your home
Sure, you don’t get to deduct as much mortgage interest. But you’ll never recoup the interest in the form of tax savings — even though the tax deduction is 100% of the mortgage interest (in some cases), the tax savings is based on your marginal tax rate, which is always less than 100%. Even if you take into account the lost tax savings, since you’re going to be paying the principal back anyway, pre-paying part of that principal is like getting a return on that payment (in the form of interest savings) at a rate that is a little less than your mortgage rate!
Increasing your risk of foreclosure and, therefore, the risk of losing your equity
I suppose if you get into trouble quickly then this might be a problem, since the mortgage prepayment is not available for other things, or if you tie such a high percentage of your free cash into prepaying your mortgage that you get stuck. But if you have the foresight to prepay your mortgage, you also probably have the foresight to see problems on the horizon, which makes this a non-issue. Prepaying your mortgage is almost always a smart move financially — just don’t overdo it and paint yourself into a corner.
Dramatically reducing the return on your equity dollars
Mr. Andrew uses the term “equity dollars” a lot. Equity is a derived quantity. It is the difference between the fair market value of your home and the liens against the home. Both of these quantities can be determined by independent means. An appraiser can estimate the FMV of your home and give you a number. The lender knows down to the penny what you owe them. But what about equity? You need the other two numbers to figure it out. You can’t call up either one of these people to ask them how much equity you have in your house.
“Equity dollars” are not real dollars that you can assign a return to — they’re just not there. What the term “equity dollars” does do is draw your attention away from your mortgage debt. Now, I’ll draw your attention back to it. By prepaying your mortgage, you will decrease the mortgage balance, and increase your equity (assuming that the FMV of your house doesn’t change). And your equity will increase faster if you prepay, because you’re saving yourself future interest payments.
“Equity dollars” are fictitious.
Decreasing your ability to sell your home quickly, at the best price, if needed
This is nonsense. The ability to sell your house depends on your asking price relative to comparable homes in the area, not how much you owe on it.
Unnecessarily extending the time required to become debt free, thereby increasing your costs
This also is nonsense. Making extra mortgage payments will always decrease the time to paying off that mortgage debt and will always reduce your overall debt.
There’s so much junk in this book, I might need to post some more of it later. Stay tuned!
5 Responses to “Missed Fortune 101 — Horrible Advice part 2”
By John on Jun 28, 2006 | Reply
Well with this kind of review I’ll be sure not to buy the book.
If interested, I have an article on my website that compares home equity loans & 2nd mortgages. A short but intesting read.
By Christian "The Smart Investor" on Nov 14, 2006 | Reply
This is great information for a person who never wants to really make any money in this world.
Sure there is some risk invloved, but with risk comes reward.
You always have to think about the future, and paying down your home is a good way to do that. I know a lot of people who pay down their mortgage so that they can own their home, and give it to their heirs. They forget to take into consideration life in general and how that can affect the future.
Let’s say for example that a person pays off their mortgage and when they retire they need care. Which is something that is not uncommon. The cost of that care could be significant, and would sometimes require them to sell their home. That gives them the equity to pay for the care and nothing for their heirs. Sometimes, that equity may not be enough to cover the costs of all things related.
Or, what happens if the person paying down their mortgage, or subsequently pays off their home gets injured or disabled and cannot return to work. They’ll be fine, because they have all that equity right? Well not if they can’t qualify for a loan because they do not have any income.
Sure their is insurance for all of these scenarios, and it is generally a good idea to purchase them. That extra cost will eat away at the money you use to pay down that mortgage, so you can be the big guy on the block talking about all of the equity you have at the neighborhood picnic.
That equity mind you, makes 0%. That’s right, you make nothing on equity at all. So if you say “I got $450,000 worth of equity in my home, and it’s paid off completely”, what exactly are you bragging about?
Sure it’s good to live a debt free life, yet having a mortgage on your credit report combined with a perfect payment history actually helps to increase your score. Plus over time, you eventually lose the tax deduction.
Now, let’s say you take that mortgage and refinance it every 2 to 3 years, and used interest-only loans. Now don’t be shocked at interest only, it’s a good way to maximize a mortgage tax deduction, and have the lowest amount of outlay in your home. Every time you refinance your home, you take out some equity and invest it. Use the monthly savings in payment that you see fromt the interest only loan versus the standard fixed rates, and dollar cost average it into a safe and reliable investment. Now you have a portfolio that will grow and will be liquid to you under most circumstances (depending on the investment). Oh, and by the way, you have something to give to your heirs.
There is drawbacks to this approach too. You can choose the worng investment advisor or invetments in general. That is why it is always good to interview the people you decide to work with, they will be responsible for handling your money! Or, your home simply does not appreciate at all. Do the research on your area bfore you buy a home, and find where the historic gains in home values have been.
I do disagree with some of the things mentioned in the book, and just like owning a home, it doesn’t work out for everybody. The overall concept is genious though. Maximize your money, and let it work for you.
You’ll never get rich by owning your things, you’ll get rich by leveraging them.
By Fan of Don Lapre on Dec 19, 2006 | Reply
Sometimes I wonder why we have made things so complicated to ourselves? Still being incharge of situations.
Fan of Don Lapre
larisa@larisajoyreilly.com
By ian baldwin on Feb 24, 2007 | Reply
Being a mortgage broker I have never met a wealthy person who has not been prepared to take a risk. Property if you have enough of them can fund a retirement and compared to pensions i know which one id rather have.
By Ann Observer on Jun 19, 2007 | Reply
Time Warner Business books has spent huge amount of money on this book. I would think they would verify a few things if their money and reputation is on the line. It is interesting to read the opinion of some two bit yahoo who can’t afford to buy the book apparently since he had to read it at BN and who, based on his lame rebuttals to some of the concepts in the book, clearly misses the concepts the author has practiced and successfully implemented for years making TREMENDOUS contributions to the lives of those who actually have implemented the ideas already. Some people would not recognize a novel concept if it crawled up their undercarriage..
Those of you who prefer co continue “mooing”, don’t bother buying the book. If you want to nut up and at least make up your own mind, spend a couple bucks to see what is in it.. and don’t be a moocher, buy the darn book you cheapskates!