Ogan Financial Group, Inc. True Wealth Management 980 Enchanted Way Suite 206 Simi Valley, CA 93065 In the News… 805.527.8806 Office 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 some financial "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 advantages.” consolidation purposes." 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 heightened competition. Beckham points to a 3.5 percent drop residential transaction volume locally in as further boosting the competition. 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 in 2006. "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 cost. 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 percent? That $100,000 would turn into $339,974. If that average is maintained over 25 years, the number balloons to $768,676. 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 term benefits?" 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 Deductions. 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.
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