Money Myth #2: The equity on my home earns an investment return
Article published in Longmeadow Neighbors
(March 2022)
EXPERT CONTRIBUTOR
CHARLIE EPSTEIN
Financial Advisor
Epstein Financial Services
413-478-8580
Yieldofdreams.live
charlie@yieldofdreams.live
When I ask the average investor, “what does the equity in your home earn..?” I usually get a perplexed look. If they are with their “significant other,” one will look at the other with that, “hey you know the answer to this question….right…look??”
So what does the equity in your home earn everyday? Let’s do a brief experiment and find out.
Let’s say you buy a house in Longmeadow for $500,000 on Captain Road where I grew up. (I know good luck with that, Charlie. Humor me) You don’t want a mortgage so you pay $500,000 cash. How much will that equity - $500,000 value - earn everyday? Before you answer, let’s say I move into the house next door to you. Our two houses are identical. Only difference is: I don’t want to use my money to buy the house. I go to the bank and get a $500,000 mortgage. I’m using OPM - Other People’s Money - the banks money instead. The mortgage is 4% for 30 years - forget about taxes and utilities, because we both need to pay those costs, my monthly mortgage payment is $2,387.08.
One year from now our houses will have appreciated to $600,000. We both sell out homes for $600,000. What is the ROR (Rate of Return) on your investment?
It’s 20%
$100,000 profit divided by $500,000 equals 20%. You made 20% ROR - not bad you proudly think.
Now I sell my house for $600,000 at the end of one year, what’s my ROR? Remember, I put no money down and used OPM.
I make 12 monthly payments of $2,387.08. A Home Mortgage is what I call Good Debt. Good Debt is the kind when you get someone else to pay a percentage. That someone else is Uncle Sam.
The first 15 years of my mortgage payment is mostly interest. I itemize my taxes, so I’m able to “deduct” 40% (lucky me, I’m in the highest marginal tax bracket). What is the “net” cost for me to borrow that money? Let’s look at the math.
$2,387.08 x 40%= $954.83.
Uncle Sam is paying this amount of my monthly mortgage, by letting me deduct the $954.83.
$2,387.08-$954.83= $1,432.25 which is my “net” monthly cost x 12 months = $27,690.12.
In the first 12 months it has only cost me $27,690.12 to buy the same house you paid $500,000 for.
I sell my house for $600,000, pay the bank back the $500,000 I borrowed and have $100,000 gross - $27,690.12 net mortgage payments = $72,310 net profit. What’s my ROR?
261%!! vs your 20%
But wait …there is even more magic. You see I didn’t use my $500,000 cash like you did to buy this property. I used only $27,690.12 of my savings. I still have $472,309.88 left to invest somewhere else. Let’s say I’m conservative and I put my money in a tax-exempt bond fund earning 3% federally tax free. At the end of the first year I have $14,169.29 of additional tax-free interest earnings. So, now I have earned the net profit on the sale of the house of $72,310 + $14,169 tax free interest = $86,479 total profit. Now what is my ROR?
312%!!! ($27,690 divided by $86,479 = 312% return!!)
The bottom line is the equity in your home earns Zero, NADA, Nothing.
Every single day.
It is a dead asset.
Wouldn’t that equity be better put to use somewhere else? Shouldn’t it be working as hard as you?
To learn more about your Myths of Money and how they impact your life and choices, head over to yieldofdreams.live and start listening to my Myths of Money Course. And if you like podcasts, download my Yield of Dreams podcast today. And if you’d like to chat with me personally, you can reach me at charlie@yieldofdreams.live or 413-478-8580
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