One of the many definitions of maturity is the ability to delay pleasure for something greater in the future. This is not a quality that most Americans seem to have anymore. People want everything now and think good old fashioned hard work is for suckers. People give into all sorts of crazy investment schemes which are extremely high in fees and low in rates of return, such as investing in life insurance products and overnight cable show’s real estate programs. In reality, these things just do not work. Another recent fad is for the ‘savvy’ investor is to invest in the equity in his or her home.
Here’s how it is supposed to work. Let’s say that John has a home worth $100,000, and has $75,000 in equity in it. John decides that he thinks he needs that $75,000 in equity in order to invest in some hot new company and will make a lot of money on that $75,000 and after he is done investing he will be able to return that $75,000 in the house and keep whatever money he made from the investment. So John goes down to his local bank or credit union, and signs up for a home equity line of credit or a second mortgage. These loans are simply a secured line of credit with your home as collateral. John gets his $75,000 and invests it in the stock market, because the stock market has averaged 12% since inception, whereas his home mortgage is only 6%, so he’ll be making 6% off the top, for free! It is actually better than låna pengar med betalningsanmärkning och skuld hos kronofogden where the interest can be quite higher. Home equity is always on top of the list when it comes to investments.
Sounds great in theory, right? Well, that’s the only place it sounds great. There are so many issues with this investment scheme that it very quickly becomes an undesirable road to wealth. First, let’s mathematically look and see if it’s -really- worth investing, getting 6% off the top might seem attractive. For our friend John that would be seemingly be $4500 a year after he pays the interest on his loan. Will it really end up being that much? No, Of course not. First, John has to pay taxes on that money. Capital gains taxes in the United States are currently 15%. This means John would only make $3100 a year instead of $4500.
This also assumes that John gets a 6% second mortgage, which rarely ever happens. A lot of second mortgage have terms which are very unfriendly to the consumer and have things such as points, origination fees, and above prime interest rates. It is much more likely that John would have an interest rate of 7% or 8%, meaning he’d be paying $6000 a year in interest, now John is only making $1650 a year. This of course assumes that the he picked good investments and is averaging 12% a year. There are a lot of years which don’t get near that; of course there are some that do much better than that too, so there are many years when John wouldn’t make any money at all.
There’s so much more beyond the mathematics though. Playing investing games such as this adds so much risk to your life. There are so many different things that could put you between a rock and hard place that would have otherwise not been an issue. What if the lender thought John missed a payment even though he didn’t? It does happen. What if John lost his job and wasn’t able to make the mortgage payment any more? If John has his house paid off, the house would be his, and there wouldn’t be anyone that could take it from him. There is a value to actually owning your home, the grass will just feel different and you will be secure in your person that nobody can take it away from you, no matter what happens.
I’m not denying there might be a few cases where people could make money doing this, but you would have to do everything exactly perfect, get the best loan, make the best investment, not be tempted to spend the money you are investing, not having anything going wrong in your life preventing you from making the payment, and let’s face it, we’re not perfect, and life isn’t always going to go according to plan.