Home Mortgage Leverage SUCKS!
|December 28, 2011||Posted by Roshawn Watson under Uncategorized|
By: Roshawn Watson
An article was circulated last week where the author lamented losing the leverage benefit of having a home mortgage; he paid off his mortgage in less than 2 years and regrets his decision. He wishes he would have invested the money instead, so it would have doubled like his other investments. Now, from my few interactions with the author, he really seems like an insightful guy who has done some wonderful things in his former career and currently as a money coach. I’m also a subscriber and a personal fan of the blog that it was published on, so I have some inherit bias. Nonetheless, my reason for writing this post is simply to provide you with a counter-perspective: home mortgage leverage sucks!
I Would Have Paid Off My Mortgage Rather Than Invest More Because Opportunity Costs Are Part of The Costs Of Doing Business
Barb Friedberg made a particularly insightful comment on 4 Things To Stop Doing With Your Finances. She wrote that it’s important to “ignore sunk costs,” as they are “part of doing business.” With that framework coupled with one of the most important lessons in Rich Dad, Poor Dad, which is “Mind Your Own Business,” there is a powerful and relevant takeaway: since your household finances are your business, there will likely be some opportunity costs necessary in order to ensure sustainability. Thus, these lost opportunities are indeed expected in most healthy businesses, including your household. This is the very same reason it is pointless to bemoan maintaining an adequate emergency fund (EF). Yes, it is true, keeping an EF means you forgo the opportunity to put those dollars to work (i.e. in the market), but the EF also provides you a better foundation to withstand the storm.
I Would Have Paid Off My Mortgage Rather Than Invest More Because I Consider Risks When I Compare Returns
If you are going to use a hypothetical scenario as a basis to justify keeping a mortgage so that you can invest more aggressively, then why wouldn’t you incorporate the risks associated with indebtedness into the model? It’s only fair because a paid off home is inherently less risky than a mortgaged home. Without a mortgage, there’s less concern for foreclosure, fewer issues with cash flow, significantly more money to invest, etc. Thus, financially speaking, risk matters, so it should be mathematically accounted for (i.e., a risk-adjusted rate of return). That’s certainly how insurance companies do business, and they don’t lose money. It’s a numbers game, while one policy may be “costly,” in aggregate, there are thousands more policies that more than make up for the few times the insurance company pays in excess of the premiums they take in for any given policy. Additionally, this is why companies have risk management divisions (for a great movie example of how important Risk Management is to a business, watch the new movie Margin Call). Properly accounting for risks means that one would have to downwardly adjust the rate of return if he or she chose to keep a mortgage so that he could invest more. This isn’t pessimism as much as it is due diligence. Eighty percent of families WILL have a major financial expenditure within the next 10 years. Now, imagine the risks incurred by keeping that mortgage for 30 years. A plan that only works if everything works out well, is not much of a plan anyway.
I Would Have Paid Off My Mortgage Rather Than Invest More Aggressively Because I Don’t Know the Future
There’s an old saying that if you want to be rich, figure out where everyone is trying to go, and get there first.
Depending on when you run the numbers, the market could have easily been significantly up or down. This lack of reproducibility is perhaps the biggest limitation of using a single case study to substantiate a point, such as using mortgage leverage to invest more aggressively. There’s a preponderance of evidence suggesting decreasing your debt-to-income ratio will improve your overall financial health, but is there solid data supporting short-term speculation in growth stocks? Moreover, any perceived advantage obtained using debt as leverage is often mitigated once risk and taxes are accounted for.
I would also argue the market is getting hard to predict, as the volatility index has increased in recent years. The cyclical and volatile nature of the market are the reasons investments are for the long-term. It’s always easy to say in hindsight that if I would have invested in stock XYZ, I would have tripled my money. That doesn’t mean that it was a mistake to avoid stock XYZ. Your total financial picture is relevant because you don’t know what stock XYZ will do, and it is your responsibility to allocate your resources to the best of your ability. You may suspect outcomes and be armed with your best data, but in the end, there’s no certainty about stock XYZ’s future performance. In contrast, one could say with certainty that nearly all homes that are foreclosed on have a mortgage (or at least a lien).
Being clear about what I do and do not know, my values, and what financial stress I do not want in my life makes paying off the mortgage an easy choice for me.
- If your cash flow is large enough that you can eliminate a pay off your entire mortgage in less than two years, 1) the mortgage likely represented a small part of your financial world and 2) since the mortgage payoff period is relatively short, you have a long time to financially recover from the alleged “mistake,” assuming your income doesn’t decline. During this recovery period, you can invest mortgage free!
- The “mistake” paying off one’s mortgage is easily rectifiable. If you want a mortgage on a paid off home in a nice area, there are plenty of bankers who would be more than willing to oblige. While you did miss a bull market or two, there’s surely another one coming alone.
- There’s no guarantee that the money used to pay off the mortgage would have gone into investments anyway. While we have the best intentions, sometimes having an unrealistic goal, such as paying off a mortgage in a ridiculously short time, is enough to correct behavior that would otherwise not be as disciplined.
In summation, regardless of whether you are a traditional worker, self-employed, or a business owner, you are in business for yourself. Minding your own business doesn’t just mean investing for growth, it also means controlling risks, including debt. Leveraging yourself for the next 30 years, which for most people represents 25-33% of their income, is a decision that has serious financial implications. In fact, housing expenses of those with mortgages are approximately 3.5 times the expenses of those without mortgages; that affects opportunity too!There’s a reason it’s emotionally difficult to go from a paid off home to a mortgaged home with a volatile portfolio. Your heart is leading you to prosperity and safety. Are you listening?
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Copyright 2012, Roshawn Watson, Pharm.D., Ph.D. All Rights Reserved.