Many of you have heard me over the years talk about the logic of whether it makes sense to pay off one’s house or if it makes sense to use that money to build greater wealth instead. I called this “equity repositioning”—that is, take equity from your home and redeploy it into a place where it would earn a greater return. In the time where credit lending is tight, asset values in real estate and the stock market are down (or even), and where people are unemployed and financially stretched, the concept that you would not pay your house down seems anathema. Over breakfast last week my mortgage industry colleague asked me with a hint of a derisive chuckle, “So what do you think of equity repositioning now?!” My response was: “My advice was dead right on. Still is.”
The smart use of debt
Equity repositioning is nothing more than the concept of using debt wisely. When we use other people’s money to make more money because we are making more money by investing than the borrowed money is costing us, we come out way ahead on very small margins over long periods of time. I never advocated financial irresponsibility, frivolous spending, or unnecessary risk-taking. To the contrary, my message was this: Financial security is defined as having the ability to weather any financial storm or be able to take advantage of any financial opportunity that comes along. When we tie up all the money in our homes by paying down our mortgages we are (1) forgoing the opportunity to make money on that money because the rate of return of home equity is ZERO; and (2) we are putting that money in an illiquid place that can be difficult to access.
Never has the consequence of a decision to pay off one’s home been more dire than it is now. Lending is so tight that people can’t borrow against their homes to help meet cash-flow needs due to unemployment or illness. People who don’t have access to cash can’t buy all those things that are on sale right now, like real estate. People who have put all this money into their homes are not only watching that money “disappear” with declining home values but they’re also kicking themselves for not having the ability to buy the house next door. For those who did it right—they bought a house, put little down, kept other assets working for them—they are sitting in a much more financially secure place. Ironically, these are also the folks who are getting their loan modifications approved and even having their second mortgages forgiven.
Am I glad I told clients that cash was king and to sock their money away somewhere other than their homes? You bet. So are they.