11 Reasons to Carry a Big Long Mortgage - Reason 2

This article has been around since I was originating loans and it was recently updated on Ric's site. I thought I'd take each one of his comments as a single post and share a few comments for those of you not familiar with this article or Ric's original claims about keeping the biggest and longest mortgage you can afford.

"His words in Blue", my words in white. I'll deconstruct his key points.

SHOULD I PAY OFF MY MORTGAGE?

11 great reasons to carry a big, long mortgage.

Ric Edelman – Edelman Financial Services

REASON #2: A MORTGAGE WON’T STOP YOU FROM BUILDING EQUITY IN THE HOUSE.

Everyone wants to build equity. It’s the main financial reason for owning a house. You can use the equity to help pay for college, weddings and even retirement. Mortgages are bad, many people say, because the bigger the mortgage, the lower your equity.

PARTIALLY AGREE: everyone wants to build equity (wealth) as stored money (energy) for future use. I believe there are many other non-financial reasons to own a house, but we'll stay financially focus for this series. What's confusing to borrowers here is the contention that 'because the bigger the mortgage, the lower your equity' isn't true. All the money you have on your balance sheet at closing is your equity. The question is about location, location, location - do you choose to put more inside the house or leave more elsewhere? Most of what I've heard Ric say about this topic over the years makes it sound like it's only your equity when it is in the house.

Example: I have $100,000 in savings. I am buying a $400,000 house. If I put $100,000 down and borrow $300,000 I have $100,000 equity in the house. If I put $50,000 down and borrow $350,000 I have $50,000 equity in the house and $50,000 equity in my savings, that is still my equity.

But think about it differently. Say you buy a house for $300,000 and you get a $250,000, 30-year, 3% mortgage. Your down payment ($50,000 in this example) is your starting equity, and you want that equity to grow, grow, grow.

TOTALLY DISAGREE: The only way it grows is through appreciation! Principal repayment is not equity growth - it is always balance sheet neutral! It is equity INCREASE, not growth... i that you are increasing the equity in the house. Equity GROWTH comes from the house being up 3% this year. My $400,000 house is now worth $412,000, and my equity has grown by $12,000 (this was money not on my balance sheet until the bonus), but if I get a bonus of $12,000 from my employer at year end, and I pay down my mortgage by $12,000, that is mortgage reduction through equity increase, not equity growth. My mortgage balance would drop by $12,000, but my checking account where the $12,000 was deposited from my employer also drops by $12,000. This is a completely misleading statement around 'grow, grow, grow.'

By making your payments each month, your loan’s balance in 20 years will be just $86,699. This supports the contention that equity grows as you’re paying off the mortgage and that, therefore, the faster you pay off the mortgage, the faster your equity will grow.

TOTALLY DISAGREE: This shows that over time your wealth is transferred from your available cash flow for spending toward paying down your principal. You are not wealthier, as you are repaying the loan with your money. (again see above statement). To pay down your mortgage from $250,000 to $86,699, you had to take money you had in your checking account ($163,301 to be exact) and pay that principal back over time.

Example: If I buy a $300,000 house and paid cash for it, then per Ric's example don't I have equity growth of $300,000? If I borrow $150,000 and pay it back over 30 years I have equity growth of $150,000... that is simply not so. I have equity increase of that amount in the house but no wealth has been generated, only price appreciation creates new wealth.

But this thinking fails to acknowledge that this is not the only way you will build equity in your house. That’s because your house is likely to grow in value over the next 20 years. If that house rises in value at the rate of 3% per year, it will be worth $541,833 in 20 years! You’ll have nearly a quarter-million dollars in new equity even if your principal balance never declines!

TOTALLY AGREE: If the house goes up by 3% and it is worth $541,833 in 30 years, you have increased your wealth by $241,833. That is real equity growth. That is the only way you will ever have equity growth, is if the house appreciates. If it depreciates, you will have equity decay by that same amount.

TIP: All money is balance sheet neutral the second it hits your checking account. Once there it is all about location, location, location - where do you employ that money for the highest return.