To own a house is to check a box off American dream for many people. Many people become attached to their house because this is their home, a place where kids grow up, a comfort zone we run back from stressful jobs and traffic jams. No wonder so many businesses built around people attachment to their house and people fear of creditors. There are myriads of ads on internet suggesting how happy one becomes when he paid off the house. Hey, just look at this dancing fella… he paid his house off… he has extra money to spend now… he owns the house now… why don’t you refinance with us and pay off your house faster too? Well, if you do you might be making a mistake. Do you know rich people never pay off their houses? Keep reading to find out why!
One person I know followed advise of his relative, set his family life aside for 15 years and put every penny into repaying his house mortgage as soon as possible. When he did, he indeed got extra money in his pocket and decided to go and get a professional financial consultation from a local licensed professional (doctor for your money). When advisor heard the story, he instantly stated that the guy made a big mistake by repaying his house. He advised the family to buy another house, never pay it off and rent out the house they paid off already. Why? Because numbers don’t lie. See for yourself below.
Before we start, take a minute and ask yourself a few simple questions.
Question 1: What interest rate bank paying you for equity in your house?
The right answer is “0%”. Regardless of how much equity in your house you own, $100K or $500K, it is just that – equity. It grows and shrinks along with your house value, with market fluctuations, but nobody paying you any interest on it.
Question 2: How much of your house equity is at risk in case of a sudden market downturn or court order?
The right answer is “100%”. If the housing market turns down, you lose your equity. If somebody sues you for whatever valid or made up predatory reasons, the court will demand you to sell your house and pay damages to victim or predator. You can lose your equity entirely or partially but the bank never loses its share of your house. That is how mortgages are structured.
Question 3: If you consider equity in your house as an investment then how good is an investment that brings 0% interest and carries 100% of the risk?
The right answer is ‘bad’. In fact is is not an investment at all. Investment is something that earns money. Equity in your house is not earning money. It is storing money at 0% interest and 100% risk.
I hope now you understand why rich people never pay off their houses! They are financially educated. As house prices go up, and equity in their house grows, rich people take equity out and invest in instruments that bring 8%-12% interest and protected from loses, creditors and predators. We will show you two scenarios with specific numbers below. This will change how you see your house equity, bring you more money long term all while it is still live in your sweet home!
When people see this, they struggle to believe. People asking where is the catch. There is no catch! Numbers don’t lie. Rich people know that and constantly pulling money out of their houses and shift risks back to banks. Let’s play few “what ifs” here:
What if the market turns down and my house worth half of what it was?
Both brothers may continue to live in their house as long as they continue payments. Brother B has more cash so he is better off. Both can go to a bank and try to renegotiate their mortgages. Brother B has a better chance because he has less equity in the house and less to lose in case of foreclosure (he shifted more risk on a bank). Both may decide to foreclose on the house. Brother B, however, has the cash to go and buy another house (or two).
What if the market turns up and my house worth double of what it was?
Well in that case both brothers have a nice and equal gain of equity. It does not matter if you own 100% of the house or 10% – gains are yours 100%, not banks. Brother A will do nothing and just enjoy extra equity he might have to himself when he sells the house. Remember when he sells the house he might even pay taxes on the gains he had gotten. Brother B will refinance the house, take equity out and invest. Brother A will continue making 0% on his equity and carry 100% of the risk, while Brother B will start getting 8% compounding gains and no risk. He will use these money to buy another cheap house if market crashes.
Cash is king, knowledge is everything!
Wallio: from Wallet to Portfolio