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Mortgages; The Misunderstood Financial Instrument February 12, 2008

Posted by shaferfinancial in Uncategorized.
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The next financial strategy is equity management of home equity. Or getting the largest mortgage you can afford in order to seperate home equity and put it to work for you. Now your alarm bells should be really ringing. Isn’t paying off your mortgage the #1 financial goal? Don’t people do all sorts of fancy things to get that mortgage paid off? But why?

No financial instrument has created more wealth for the middle class than mortgages. A bold statement but demonstrably true. Not stocks, not mutual funds, not annuities, nor bonds. But how can this be? How can debt create wealth? Very simply, mortgages allow for the middle class to purchase real estate, something they could not do without this financial instrument. Mortgages allow one to leverage their money into control of a larger asset. Mortgages are cheap money, made cheaper by the tax laws. This combination has allowed people to create more wealth in their homes than any other place.

The median amount of home equity in primary homes is $65,000 for all homeowners. The median total net worth for all families is $93,000. So, in short for Americans, much of their wealth is held inside their homes. So why if mortgages are so successful in building wealth for people are they in such a hurry to get rid of them? That is literally the million dollar question.

Unfortunately, people usually don’t understand how holding their wealth inside of their homes is a very risky position as well as a financially dumb place for holding their wealth. Now, you can’t argue that mortgages has allowed for the middle class to build more wealth than any other financial instrument. You are left with the emotional baggage of thinking all debt is bad. This is also demonstrably false.

So now we understand where the most wealth is for Americans, the question remains how to put that to work for you? See my post on equity management for details, but the bottom line is this strategy works because it takes a hidden asset (home equity) and puts it to work for you in a safe liquid environment. Most Americans (90%) have been unable to save more than a pittance anywhere outside of their homes. The success of this strategy is built on the fact people are successful (over 99% of conforming loans are paid back) in using mortgages to build wealth, while people are not successful in their other wealth building endeavors (ie retirement saving, stock ownership, mutual funds, etc.). Use what people are good at to build wealth…..what a concept!

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Comments»

1. joetaxpayerblog - February 14, 2008

Curious where you got those numbers.
I found a census report that showed median net worth in 2000 $$, of $49,932, against $59,000 of home equity. The report is at http://www.census.gov/prod/2003pubs/p70-88.pdf
This is the median, which skews things in an odd way, doesn’t reflect the typical homeowner just a statistic.
JOE

2. shaferfinancial - February 27, 2008

Sorry your comment got caught in my spam filter.
Here is the web address:
http://www.federalreserve.gov/pubs/oss/oss2/2004/bull0206.pdf

Not sure what you mean about median statistic skewing in an odd way. It is a straight forward statistic, half above and half below. Average is a statistic that is skewed when you have outliers that are significantly far away from the middle as we do with wealth. I’m not sure what you mean by typical homeowner?? Typical is an undefined variable. But the median is a very well defined variable that everyone can agree on its meaning, so I use it.

3. joetaxpayerblog - February 28, 2008

Trying to reconstruct my thought from two weeks ago.
I believe I was thinking this; That median is good, since average can be skewed by the few rich. That’s how we get median incomes of $45K or so, but average in the $70Ks. But when you line up two medians, say median house, and median mortgage, they may not be the same homeowner, it may be shifted enough that it’s off by quite a bit. Just my thoughts on this.
JOE

4. shaferfinancial - February 29, 2008

Well, we are talking statistics here so it does not try to reconstuct any single individual. My experience in talking to hundreds, if not over a thousand people and pulling credit on many of them tells me that the median numbers are representative. Also, if you understand statistical inference then you understand that going out 1 standard deviation either way encompasses the majority of folks. This tells us that most people are pretty close to the median. But the point is that by any accounting you use, the majority of folks have not accumulated much wealth! As I search for the answer I refuse to accept “because folks are stupid or undisciplined” or any of the terms the financial community uses to excuse the failure of their advice! And as much as I admire Bogle and his low expense mutual funds, I don’t think it really solves the problems that keep people from accumulating wealth.


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