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Should You Bet the House?
Homeowners Weigh the Risks of Investing Equity
By George Waldon
MORE HOME owners have become comfortable with carrying more debt on their homes and using the
residential equity as a cash pool for investment. For many homeowners, two of the biggest factors that
affect equity growth have remained favorable for the past several years.
Home values in general have seen solid, even strong, annual appreciation, and in some hot spots in the
United States, including in Arkansas, values have soared into the financial stratosphere. While values
trended upward at a sometimes eyebrowraising pace, interest rates fell and have remained low.
With these two forces in play, leveraging home equity has grown in popularity as a wealthbudding tool.
The three basics for human survival, however, have remained the same: food, clothing and shelter. So
despite the potential benefits of leveraging home equity in the current financial atmosphere, people's primal
feelings about shelter, and protecting it, often win out over cold numerical calculations.
Rod Beckham, branch manager at First Financial Mortgage's west Little Rock office, said the most common
kind of home equity investing he saw was homeowners selling their houses and buying nicer ones.
This often entails homeowners using sale proceeds to cover 20 percent of a
new home's purchase price and plowing the balance into a stockmarket “Putting money to
investment. work instead of
leaving it in
Beckham said converting home equity to investment cash through a sale passive storage in
was much more common than homeowners staying put and pulling money the form of home
out through a refinance.
equity can have
"People buying and moving up that's the only place we see it for investment
purposes," he said. "We do see people refinance their house for debt
Beckham thinks that a home equity loan is the most popular vehicle for freeing up cash to invest for
homeowners who are staying put.
Rather than refinance a lowinterest, longterm first mortgage into one big loan at a slightly higher rate to
convert equity into investment cash, these homeowners are choosing to keep the first mortgage intact and
take out a home equity loan.
The increased demand for home equity loans, a niche once filled primarily by local banks, has attracted the
attention of the nation's largest Mortgage lenders during the past five years, lenders such as Countrywide
and Wells Fargo.
The mounds of marketing mailers received by homeowners soliciting home equity loans bear witness to the
Beckham points to a 3.5 percent drop residential transaction volume locally in as further boosting the
Another example of the increased acceptance of leveraging homes is the growing number of borrowers who
finance 100 percent of the purchase price of their homes.
Beckham said that 100 percent loans accounted for less than 1 percent of First Financial's residential lending
during 2004. That number grew to 4 percent in 2005 and leaped to 12 percent in year todate comparison
"The 100percent loans have come to Arkansas and are now becoming more prevalent," he said. "My guess
is that about half of them are firsttime homebuyers."
These firsttimers are a mix of those who can't afford to make a down payment on the house and those who
simply don't want to tie up their cash in a house beyond the monthly mortgage payment.
The RiskBenefit it Analysis
Putting money to work instead of leaving it in passive storage in the form of home equity can have some
financial advantages. It's easy to see the attraction of home equity leveraging by plugging in some numbers
and watching time and money work their magic.
Take, for example, a couple who sell a house, make a 20 percent down payment on a new one and have
$100,000 left over.
They could spend that cash on nicer cars, plasma TV sets or other upgrades of their material possessions.
They also could use it to make a hefty down payment on the new house and lower their monthly mortgage
But what if that couple can afford the new house payments without the $100,000 coming into play? What if
they invest the money in a mutual fund that over 15 years produces an average annual rate of return of 10
That $100,000 would turn into $339,974. If that average is maintained over 25 years, the number balloons
And if that investment yields an annual average rate of return of 12 percent, we're talking $429,263 in 15
years. That's a whopping $1.1 million if the pace holds for 25 years.
Calculating these equations can make the idea of tying that $100,000 up in a house appear foolish. How
could it make good math sense to park the money in a house to lower the payments on a mortgage of less
than 6 percent?
A tidy tax break associated with home ownership also aids the home equity
“Why not borrow leveraging formula.
more by leveraging
the equity and go With certain tax bracket considerations, a $2,400 house payment is
for a double digit effectively reduced to $1,700 because of the benefits of deducting the
investment return interest on a home loan. Or it could be viewed as a lower interest rate. For
instead of tying up example, today's 5,875 percent interest rate on a 30year fixed rate
mortgage is lowered to just below 4 percent if the writeoff for a homeowner
the money and in the 25 percent tax bracket is considered.
borrowing less on
a 4 percent loan?”
It makes the possible spread between the mortgage interest and potential
investment yields even greater.
Why not borrow more by leveraging the equity and go for a double digit investment return instead of tying
up the money and borrowing less on a 4 percent loan?
Rick Adkins, chief executive officer of Arkansas Financial Group Inc., said evaluating the pros and cons of
such a move by calculating an investment barometer such as the net present value of the aftertax cash
flow does make hard mathematical sense. It's logical. But, Adkins said, behavioral and emotional factors
also enter the human decisionmaking process when it comes to money.
The reality is that the decision is more complex than a CPA spawned number with a longwinded name.
Adkins said he worked with a client who asked him to run the numbers on leveraging his home equity. The
client liked what he saw.
They talked through the possible upsides and downsides, including the basic
point that leveraging creates risk and the existence of financial gravity. Assets "You don't do
that go up in value can go down in value or, at the least, not increase in value this kind of
as quickly as past history or forecasts might indicate. transaction and
evaluate it a year
Forewarned and forearmed, the client made the leap into leveraging his home later," Adkins
equity only to be racked by investor's remorse when the hopedfor returns
didn't pan out according to plan during the first year.
said. "You look at
it five years later,
"You don't do this kind of transaction and evaluate it a year later," Adkins said.
10 years later.”
"You look at it five years later, 10 years later.
"If my client would have employed his investment strategy In 2001, he would've had to live through a blood
bath in the stock market. That's the dilemma. Can you handle the shortterm volatility to enjoy the long
His anecdote highlights the issue of risk tolerance. The client thought he had the stomach to ride out the ups
and downs of the stock market.
Adkins convinced the client that despite his change of heart, the prudent thing to do was not panic and sell
at a loss but to ride out the downturn with an eye toward better days.
"It's one thing if you put the money 'in something that goes up in value, but we've had some periods where
that doesn't necessarily happen. But from a longterm perspective, investing in the stock market in general
will turn out OK."
Discipline Equals Wealth
It is a timehonored ritual to build wealth through the appreciating value of a home combined with the
increased ownership over time as a mortgage is paid off.
Leonard Hasson of the Little Rock CPA firm of Mann & Hasson said that while some might consider the debt
represented by a mortgage as a bad thing, the repayment structure of home mortgage is a good discipline.
From what he's observed, Hasson said, many people who are taking on more debt through home equity
loans aren't leveraging to build wealth; they are tapping their house to increase their disposable income to
buy nonincomeproducing things.
And this phenomenon, Rick Adkins said, is something to be faced when considering the pros and cons of
leveraging home equity.
"The danger of access to cash via a mortgage is like financial heroin for some people," Adkins said. "It may
be cheap to borrow, but at some point it has to be repaid."
Peace of mind is tough to place a value on. Even if the numbers look good and make sense, home equity
leveraging isn't for everyone and likely won't become the norm anytime soon.
Copyright Arkansas Business Nov 06, 2006
(c) 2006 Arkansas Business. Provided by ProQuest Information and Learning. All rights Reserved.
OFG: Homes were meant to store families, not cash. When leveraged
into a safe, liquid side account that offers TaxFree Accumulation, Tax
Free Withdrawal and TaxFree Transfer, you can catch up on 2030 years
of retirement savings through the one time separation of home equity
that can carry you through retirement while maximizing your Tax
To learn more about how to safely and prudently leverage your Home
Equity, and the wisest and safest places to allow those dollars to grow,
through the Missed Fortune book series by Douglas Andrew or by
visiting our website at www.oganfinancialgroup.com.