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How Much Money Would You Deposit In This Investment?

Conventional wisdom does not always apply. Consider this investment:

  1. You determine the length of time and monthly amount you want to contribute.
  2. You can always contribute more, but never less. If you do contribute less, all previous contributions will be forfeited.
  3. The monies you deposit are not safe from a loss of principal.
  4. The monies in the account are not liquid.
  5. Your income tax liability actually increases with every contribution.
  6. Your money earns a 0% rate of return.
  7. When the investment is fully funded, there is NO income paid out.

On these terms, I have yet to have a customer be eager to put money into this investment. As a matter of fact, most are shocked to find out that they have been encouraged to put a large portion of their income in this exact investment! You see, the investment described above is Home Equity – whether it be through a larger than necessary down payment or through pre-payment strategies or even the regular amortization created by taking a shorter term.

Let’s look at the terms of the stated investment one more time:

  1. Take a 15, 20 or 30 year loan
  2. You can always pay additional  money towards your outstanding balance, but if you pay less, and get foreclosed upon, you lose all your payments to reduce the principal.
  3. As home values have declined, the monies invested (either from your down payment or other equity reducing strategies) have declined, and your cash has been lost.
  4. Home equity is not liquid. You cannot just go get it when you need it. As a matter of fact, usually when you need to access it most (a job loss, disability, or worse) you can’t get it at all, as you won’t qualify for a loan.
  5. With each payment on an amortizing fixed rate loan, you are paying more principal than you did in the previous payment. That means you are paying less interest. Since interest is the deductible portion of your payment, with each payment you pay less interest; therefore, less tax deductibility.
  6. Home Equity has 0% rate of return. Ask yourself, “What interest rate will the bank give you on your down payment?” The answer is “Zero”. The same holds true for any reduction in principal. Any money used to increase equity (defined as the difference between the home’s value and its outstanding debt) will have a 0% rate of return.
  7. When your home is paid off, there is no money paid to you. You are left with a large equity investment, gaining no rate of return.

Bottom Line

There are many factors to consider when deciding what mortgage fits your personal situation. You need to completely understand your individual, short and long-term goals. The “conventional wisdom” is not always the wisest solution. You should seek out the counsel of a good loan officer who understands your goals.

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  1. […] forget it turn off your computer and hit the bricks!!! by: mister ed on: 31st August 07 Mouse here for Related LinksHow Much Money Would You Deposit In This Investment? […]

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