The 4 Stages Of Wealth Building As A Homeowner

One of the primary objectives of owning a home is to let the home appreciate over time and become a pillar of a family’s financial strength.

But before we can discuss “wealth”, we need to identify the stages to get there.

Stage 1

Having “Emergency Cash” is the first stage. It’s having $5-7,000 liquid for life’s inconveniences (the boiler breaking down, the car needing work, etc). When faced with the inevitable challenges that arise, many people are forced to run to their credit cards to make it through. They become stuck with high interest rate, non-tax deductible borrowing.

Stage 2

The second stage is the elimination of “Bad Debt”. We define “Bad Debt” as any debt whose interest is not tax deductible. Obviously, those high interest rate credit cards must be the first to go. But we also want to divest ourselves of the borrowing associated with car loans, boat loans, student loans, and personal loans because it typically can be done cheaper.

Stage 3

Shockingly, when you arrive at stage three, you will be considered in the Top 5% of Americans in terms of financial security. Stage three is accomplished when you have 3-6 months of your total expenses in reserves. The average homeowner (who is logically financially better off than the non-homeowner) has less than one month’s expenses in reserve! When life shows them more than a minor inconvenience (like a job loss, an illness/disability, or worse), most people are in a panic situation. With 3-6 month’s reserves, you will have time to weigh options and make better choices.

Stage 4

True financial security is attained when you become “Debt Free”. But not without debt. We consider our clients “Debt Free” when they have enough liquid assets to pay off whatever mortgage they have outstanding. Wealth building almost requires utilizing the tax benefits of having a mortgage in combination with strategies that utilize The 3 Miracles of Money…

The 3 Miracles of Money

1.       Compound Interest – The impact of money left to grow upon itself can be dramatic. If you had $1 on Monday and you could double it every day ($2 on Tuesday, $4 on Wednesday, etc.), by the end of 20 days, you would have $1,048,576.00!!! Now, you can’t double your cash every day, not even every year, but the concept holds true…..compounding interest is a good thing!

2.      Tax Free Growth – The ability to accumulate assets without giving Uncle Sam a third of it (in the form of Federal and State Income Taxes) is how the $1 became $1 million. If the growth was taxed at 33% ($1 on Monday gave you $1.67 on Tuesday – instead of $2- and so on), your $1 would only grow to $28,466.20 after 20 days!!! THAT IS NOT A TYPO! You would have “lost” over $1 million.

3.      Leverage and Arbitrage – If you can put up a minimum of cash and take title to a significant asset (like a down payment on a home….the smaller the down payment the better), you can leverage that cash investment to large returns. At the same time, if you can take the cash that you don’t bury in home equity and effectuate a spread between your “after tax cost of money” (mortgage payment) and your investment options (hopefully, in a tax free environment), you can gain the exponential growth that creates wealth.

Special thanks to Dave Cook for providing this information.  

Want to know more about home ownership?  Call me, Laura at 303-726-1051.

THE MORALITY OF SHORT SALES

Is walking away from a million dollar + home, when you’re $250,000 upside-down immoral or simply a business deal that didn’t work?

This question was put to the group of professionals attending the Real Estate Trends class at last week’s Stewart Title Success Summit, and the ensuing discussion was spirited to say the least. I love to hear what you think!

Here’s the scenario:

A family buys a beautiful new home in 2006 for $1.5M. Remember, at that point in time it was still possible to get financing based on stated income and without putting any money down. But for our purposes here let’s say the homeowner does have some skin in the game - say they put 5% down or $75,000. They move in and live happily paying the monthly mortgage as promised. Now fast forward to today.

We are well into the recession, the mortgage market has gone through some violent and not-so-violent revolution, home prices have gone down, as have interest rates. The $1.5M home is now worth much less, maybe as much as $250,000 less and if the family were in a “have to sell” situation they would be putting their home on in a glutted market with 7 years of competing inventory. They are paying a mortgage based on the $1.5M price and looking at homes down the street or around the corner that are selling at today’s depreciated prices and in a lending market with amazingly low interest rates.

So, Mr. $1.5M homeowner looks at his asset sheet and says, “Wow, I’ve got a liability here. I’m paying on a $1.5M mortgage but the house is only worth $1.25M. I could get a better interest rate, protect my credit, and fix my asset sheet. All I have to do is give this house back to the bank, let them do the short sale, and I’ll go buy that beautiful place around the corner. Oh, and by the way Mr. Banker, would you give me a loan on my new place?

This scenario is actually happening and the number of times it happens is promising to grow in numbers for the next 2-5 years depending on how one looks at the statistics.

I’m guessing that many of us can see our way to why a short sale can be a welcome relief and justifiable to the homeowner who was put into an adjustable rate mortgage on a home in the under $200K range and are now dealing with an 8% or higher interest rate. Or we feel OK with it if the homeowner lost their job, or had a medical crisis that clobbered their savings, or lost their equity in an ugly divorce or, . . .

So, does a higher price point, more generous income stream, and the ability to buy a new home at a better price and interest rate make a difference?

The other side to consider is this. The purchase of a home and the agreement to repay a mortgage is, at its heart, a business deal. At its essence, the agreement looks like this - the home-buyer says: “Bank, if you lend me the money to buy this home, I agree to pay you (fill in the blank) amount for this period of time, at this rate. And if I don’t pay you, you have the right to take control of the property in the way you see fit.”

So again I ask, the question, “Is walking away from a million dollar + home, when you’re $250,000 upside-down immoral or simply a business deal that didn’t work?”

I stand with my Managing Broker, Charles Roberts, who initially posed the question in the session last week – I’m not particularly interested in passing judgment. I’m much more fascinated by the fact that this conversation is even taking place and what it means for our society in the future.