Hello My Favorite People:This week I want to share some ideas about building equity outside of your home instead of inside— they come from two books: Missed Fortune by Douglas R. Andrew and The Truth About Money by Ric Edelman. Both were recommended to me by SF mortgage planner, Steven Hook (thanks, Steve!)

Thousands of financially successful people who have more than enough money to pay off their mortgage, refuse to do so. Instead, they build equity outside of their home instead of paying down the principal. This prevents a sizeable chunk of their net worth from being tied up in a single asset and gives them more financial flexibility and freedom.

To illustrate the benefit of not being eager to pay down your mortgage, here is the story of two brothers: Each secures a mortgage to buy a $200,000 home. Each brother earns $70,000 a year and has $40,000 in savings.

The first brother, Brother A wants to own his home free and clear as quickly as possible. He bites the bullet and gets a fifteen-year mortgage at 6.38% and shells out all $40,000 of his savings as a 20% down payment. His monthly payment out of pocket is $1,383, but the income tax benefit of the mortgage makes his real payment is $1,227. Brother A also pays an extra $100 to his lender every month to further push his mortgage balance down.

Brother B thinks a little differently and chooses to conserve as much cash as possible. He puts down 5%, or $10,000 and invests the remaining $30,000 in a safe money-making side account. He secures a 30-year interest only loan at 7.42% with a monthly payment of $1,175, leaving him a monthly net after-tax cost of $799. Every month he adds $100 to his investments (the same $100 Brother A is paying his lender), plus the $428 he’s saved from his lower mortgage payment. His investment account earns an 8% rate of return.

Five years later, Brother A has received $14,216 in tax savings, but made zero dollars in savings and investments.Brother B, on the other hand, has received $22,557 in tax savings and his savings and investment account has grown to $83,513.

After 15 years the difference in cash on hand is even more dramatic (one has roughly $294,000 more than the other). Even after factoring in the home Brother A owns free and clear, the difference in their net worth is still $94,000. Brother B also has the flexibility to respond to investment opportunities or a crisis (like a job loss or health problems) with liquid assets.

67% of Americans have more of their net worth in home equity than in all their other investments combined. When you integrate your home equity into a total financial picture, however, you reduce your risk by diversifying your net worth into multiple investments.

This notion of separating your home equity from your home is a tough concept for me to put in practice. I’m still a bricks and mortar kind of gal who will always be more comfortable socking my money away into things I can see and touch. Even so, these are darn smart ideas—if I could rearrange my thinking, I’d be applying them in my own life to increase my net worth more rapidly.

What do you think? Are you like me? Or are you more like Brother B? I have excerpts of articles and books that expound these concepts in more detail. If you want me to send you copies, just call or email. See you next week!

This entry was posted on Sunday, March 19th, 2006 at 12:00 pm and is filed under Investors. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

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