The most visited posts on this blog are the ones about Douglas Andrew's Missed Fortune 101. The main one is here.
I still get comments every once in a while on this post. In case you haven't read the book, the crux of Mr. Andrew's way to riches (very boiled down) is to borrow from the equity in your home and use that borrowed money to purchase life insurance vehicles, with the aim being that you earn enough on the life insurance vehicles to outpace the payments you have on the HELOCs. I took issue with this because it uses a lot of borrowed money for the investment, and if the favorable spread turns for any number of reasons, it quickly become a losing proposition. That, and it just doesn't come off as sound financial advice — borrowing to invest, scoffing at IRAs and other tax-advantaged accounts, and viewing home equity as a bad thing.
Recently, Brian left the following comment:
“Interesting thread. I am a mortgage broker and have just started learning about the MF concepts. Thanks for posing the questions and challenging the theories. It seems to me the MF camp is winning the debate here. I haven’t seen a proof on owning the home free and clear yet other than “it Feels right, I sleep well at night knowing its paid for.â€
In a couple of ways, Brian's comments are accurate. The Missed Fortune supporters are outnumbering the Missed Fortune critics, as far as the comments go. And a few of the arguments that the MF supporters have against having a lot of equity in your home seem to have some teeth to them, as in:
“You could have $100,000 equity in your home, lose your job and I guarantee you are not getting a loan, won’t be able to refinance the house and get the money out, etc.” (Rick, comment 5)
(I thought that's what emergency funds are for, but I guess when those run out you're stuck.)
So anyway, I asked myself, after re-reading the threads, is Brian right? Is “sleeping well at night” really the only thing good about being debt-free?
I do know that there are good uses for debt. Leverage is powerful if you're using it to buy something of great value that will give you a positive return on your investment. But buying something of great value is not a universal talent, and if you buy something with leverage that's overpriced, you're in trouble.
What I don't understand is why, oh why, are living below your means and savings so unpopular? Some of the commenters never wanted to be debt-free. It's like not owing a dime is the worst thing in the world. Money burns a hole in their pockets first, and in the walls of their home next. And there's always someone walking by with a smoke detector offering to save all of that excess equity from just sitting on the couch, doing nothing for you.
Granted, it's been very tempting recently to borrow with mortgage rates the way they have been. When you're only paying 5% or 6% — on a loan where the interest is deductible — you don't have to be as careful with your choices as to how to put that money to work. It's also very tempting when you live in a bubble market (like I do, only a couple of hours from Washington, DC) and watch your house's value rise 70% in three years. Hey, I'm rich!! Why not tap into that equity and try something?
I must be about the most boring person in the world to a lender: Not only do I not want to borrow against my equity, but I want to pay back my loan faster! Where's the fun in that? they must wonder.
It didn't used to be this way. My father's father had to be persuaded to borrow money to buy a house — he hadn't borrowed for anything up until that point. My father only borrowed for his house (and possibly one car, I'm not sure) and paid cash for everything else — all the other cars, our college educations. My mother's family was much the same way.
My parents didn't borrow, borrow, spend, spend. They saved and paid cash. And invested.
And now they're at the point where they're not going to run out of money. Their house is paid for.
And yes, they sleep well at night.
So here's my question: If you are trying to become debt-free, why? If you're not, why not?
It depends on the type of debt you're talking about. Real Estate "debt" is good debt that builds your net worth and if it's a rental property also increases your income. But if it's debt for a car or a TV or credit card then of course you should be debt-free.
You make some good points. More people should go back to the old way of saving and paying in cash instead of being so obsessed with instant gratification. Good post!
John
One way to evaluate the question about whether to borrow agains home equity is to look at alternative investments. Let's say instead of insurance, you were to invest in other property (residential / commercial), or the stock market, or even a business of your own. Would it be a better alternative to retaining your existing equity?
There isn't a single right answer; it depends on both the attractiveness of the alternative investments, and your appetite for risk.
Leveraging is a two edged sword; you could get phenomenal returns; or get bogged down in the red if things go wrong.
My personal take on Rick's comment: I wouldn't fool around with my primary home – that's what I rely on for a roof over my head. Whether you're renting or having a mortgage payment, housing is an expense you have anyway; being in or out of a job doesn't have anything to do with it.
If I hadn't bought a home and kept up with the mortgage payments, would I have that equity in it now? Chances are, no – it'd have gone as a rental payment instead, which I wouldn't even have as an emergency fallback. As such, pulling it out has to be a conscious decision, only if doing so is going to provide an enormous return.
So back to the final question – debt-free or not, and why.
In the short term, I am taking on debt selectively, for investment; where it helps get a better return, or participation in an opportunity. But in each case, there's a clear debt repayment plan with it; after all, if there's a debt, it reduces my net worth.
Here's why I am striving to be debt free: My parents are turning 65 and they have no retirement savings or worse yet, no plan for retirement. I often joke that the guest room I added in my finished basement is their retirement plan. Growing up I always watched them struggle from paycheck to paycheck and I often laid awake at night worrying about what to pay – tuition or car insurance – even at that age I chose not to take on a student loan.
I believe these events early in my life, plus seeing my parents age with no plan led me to be a life time saver. My kids college costs are paid for even though I have 10 and 12 years respectively until they go to college, and I have a sizeable retirement portfolio. Despite all this, I strive to be debt free as I believe you never know when the rain is going to come. I am probably one of those people who could afford to take on additional debt but I know I sleep really well at night knowing I am prepared for the rainy day should it come. If it doesn't then I will have a very comfortable retirement and maybe a little left over for the kids.
I know of many friends and neighbors who live with much higher debt and these are the same people who worry about real estate bubbles and offshoring – I'm not sure they sleep as well as I do at night.
That's why I want to be debt free and will be in 12 years.
That first night after I paid off all of my debts was the best night of sleep I've ever had. If more people could understand the psycological impact of being debt free… All I can say is, "WOW".
I think you must realize that the defenders of MF also have an agenda, and that is why they post so much. I would bet good money many of them are brokers themselves.
My short term goal is to be free of credit card debt. I don't think that I will be completly debt free until I retire. I will use debt for purchasing a home,car, school or funding business expenses. I will not use debt for consumable items or for strict investments. Debt is not bad. However not fully understanding and/or appreciating the price of debt is a epedemic that has and will affect many consumers for decades to come. Our ancestors treated debt more sacredly because it was not casually given out to everyone. Many people plan to be in debt until the day they die.
Fantastic thoughts everyone. Thank you!
Kevin, it's interesting that you saw what your parents did and recognized it for what it was, and then did the opposite. You sometimes learn more by seeing what not to do than by seeing what to do.
NCN, yes, absolutely. Some of the commenters, surprisingly, seem to relish that they're living it large while they're in hock.
Joanthan, I agree. It just confounds me that so many of the brokers appear to know so little about finance.
I not only like the peace of mind that comes from being debt-free, I like the freedom it rings. I like being able to help other people who need it because my income isn't already parceled out to creditors each month.
I like knowing that if I died suddenly my children inherit their home instead of the mortgage.
I hate interest payments, and my money goes a lot further without them. If two people go out to eat and one pays ten dollars cash and the other puts it on the card, unless the card-holder pays his bills in full every month, he could actually end up spending twice as much for the meal.
Why would I be excited about putting more money in the lender's pocket?
After being debt free for years, we're building a new house. It is our goal to have it paid off in ten years or less- that's a couple hundred thousand dollars in my pocket instead of the banker's. I like that.
I am debt-free. I no longer have any student loans, credit card debt, or mortgage debt. Being debt-free is half the battle toward financial freedom to the extent that it minimizes my household operating expenses, and by extension the income needed to meet those household operating expenses. The less income I need, the less principal and/or the the less work is required to generate that income. Once I generate that principal, I necessarily have the freedom to do what I want, for whom I want, when I want. If I choose to continue to work, that's my business. If I choose to work for a worthier cause for little or no pay, that's my business. Indeed, if I choose not to work, that's also my business. I can't imagine not wanting that freedom!
So, why isn't everyone debt-free? I don't think most people make the connection between debt and lack of personal freedom. I think most people assume that if they only made more income, they'd be better off. They won't be. They'd just have more exposure to taxation. They'd just increase their consumption, thereby increasing their current expenses and/or debt. The combination will only put them further away from financial freedom.
Frankly, I don't see such people changing, absent rising interest rates.
Being newly retired (59 & 61) we relish our independence at being debt free. Everything we have we own outright. What does this mean for us – freedom, good sleeping, not having our kids worry about us. We've been thru good and bad times and have never lived paycheck to paycheck and we've never made over $40,000 a year. Just wish we had become debt free earlier in our lives. Our kids have learned that they must prepare to take care of themselves when they retire. Sure makes you think hard when you see 65+ peoplewho are 65+ with big mortgages – why did they do that? More and bigger is not the answer. Living your life frugally, but fully brings peace of mind. Peace of mind must contribute to a good healthy life – and what's better than that?
More great comments! Thank you all for taking the time to post!
The connection between debt and lack of personal freedom is a gem, Suresh.
DHM and Bellen, thinking of the younger generation and not being a burden on them is unusual. I'm thankful that my parents are in that situation, and I'm striving to do the same for my daughter. (Considering the head start I've gotten, something's seriously wrong if I can't!)
I'm not debt-free but I'm striving to be. It's a fairly slow and painful process but I'm taking it in baby steps. First the credit cards, then the HELOC. After that hopefully the cars. I want to do that for that "freedom" the others mentioned. I want all that money going out every to either stop or go towards more investing. I want less worries and more freedom!!!
As a postscript – CT is where our kids live and that state is one of several that have filial responsibility laws. We saw young neighbors (mid 40's) almost ruined financially because their parents did not plan for retirement and the feeding, housing, etc. became the kids responsiblity. Since we raised our kids to be responsible, contributing members of society it's only right that we are also. Note how responsible keeps coming up – I hope that word does not go out style!
Actually, being debt free is a very popular thing and is full of life. The question is what you are doing between loaded up with debt to being debt free. Consumer debts = bad. Student loan and Mortgage debt, a necessary item that will hopefully be paid off eventually.
Now the question is can you do better in the meantime from being loaded with debt to debt free. Proponents and planners like myself see the necessary evil or mortgage debt to build wealth. Be it in insurance, real estate or securities, properly structured and managed, you will be leaps and bounds over the family that did things traditionally. The key is properly managed. We've done workshops for thousands of folks across the country and everyone agrees that seperation of equity is financially prudent thing to do. Even critics cannot dispute that fact. But the big question is where to put it. That's what needs to be looked at very closely.
We need to acknowledge, there are no benefits given to us with having a ton of equity in a property other then feeling good about oneself(which is a great thing)
To get the money, you need to sell or finance the property…sell at a discount (& pay a 6% sales commission) in a family emergency or try to get a mortgage in a financial bind and see how fun that it.
If you have been responsible and saving and it seems like many folks here are, then you are the cream of the crop and may never have these worries. However, lets face it. 98% of the rest of Americans never save other then in their home equity. In a financial pinch or an emergency, go and see how liquid and safe their only savings is.
This plan is not for everyone, I’ll be the first on the financial planner side to say that. With discipline and time, it's wonderful. With a lack of discipline or a shortsighted vision/game plan, it can be nightmare.
Let's not fool ourselves. There is money to be made in this market, as there is in everything else out there, like 401K, investing, etc. There is always someone getting paid no matter what you do with your money. The key is to find something that you can look at objectively and find a planner that will do the same and you will find the guy that has your interests in mind. By keeping emotion out of the decision making process you can find the diamond in the rough for you and your family
mbhunter, this is a great topic, and I've been rolling it around more in my head.
Is the problem not so much that being debt-free is unattractive, but that it is less attractive than maintaining a state-of-the-art standard of living? My friend, Dave, likens this problem to a monkey who fits his hand into a jar to grab a fruit, but finds that his hand with the fruit no longer fits through the mouth of the jar. Standing outside the thought experiment, we know the solution: let go of the fruit. Sheesh! After all, we're not monkeys! Doh! Therein lies the problem.
In psychology, there is a principle of social influence by reference to authority. People are more likely than not to follow directions of or to mimic the actions of those who are perceived to be intelligent professionals. Why? People baselessly assume that among the professionals, someone must have done the hard analysis and bought into a particular plan of action. In such a case, such late-comers need only take a cognitive shortcut based on the actions of the professionals.
In the real world, where are the intelligent professionals, whom we want to model after, saying, "Develop your personal freedom! Be debt-free! Grow income-generating and/or capital appreciating assets!"? Of course, you don't hear that. Instead, you get former Dallas Fed Governor Robert McTeer who said, "If we all join hands together and buy a new SUV, everything will be OK." Or, take former Fed Chairman Greenspan, who was asked during one of his Congressional testimonies, “Do American households have too much debt?” Mr. Greenspan replied that household debt service burden was within the historical range, and that it was manageable because of historically low interest rates.
The net effect is that the thought leaders in our society are encouraging us to be life-long employees. Thanks, but no thanks.
I want to pay off my mortgage precisely so if I *do* lose my job I don't have that $1800 per month expense hanging over my head!
Personal indebtedness lines the pockets of government and big business. It’s not surprising to me that mainstream media promotes debt as a way of life. My personal debt benefits government and big business; government reaps the taxes from the additional income I need to pay my debts and big business reaps the rewards as profits on the debt and consumption from leveraged income, as well as benefiting from reduced wages paid to indebted employees. Debt means I have to work, increasing the supply
Debt free folks don’t consume as much and don’t pay as much as interest. Debt free folks don’t need to work as hard, make as much money, or pay as much in taxes.
That said, I’m in no hurry to pay off my mortgage. Why? Because my monthly mortgage debt and escrow payment is significantly below the imputed rent for my house; and my 5.125% fixed rate mortgage is a great way to short the US dollar. If I lose my job in a deflationary crisis, I’ll be able to rent the house out for a significant positive monthly cashflow. I’m not going to borrow against my house and risk that imputed rent income. Historically, most ordinary folks make money buying real estate by locking in monthly payments while rents rise over time; that difference is what they’re able to put in their pocket. In my opinion, capital appreciation of real estate is a recent and unsustainable phenomena.
For the past several years, I’ve taken the money I could have used to pay off my house and generated 20%+/yr in the foreign equities, precious metals, and energy sectors. That’s what works for me. If you’re not comfortable identifying primary economic trends and investing in them, you might be better off to lock in the guaranteed 5.125% (or whatever your mortgage rate is) of mortgage pre-payment.
I’m trying to increase my assets so that my standard of living is constantly increasing, rather than constantly decreasing (which is the case if I consume tomorrow’s income today through debt). We live in a time of unsustainable debt expansion. Those living beyond their net worth believe it that debt expansion can go on forever. I wish them the best of luck.
I focus on increasing my net worth and acquiring assets that are going to generate income and capital appreciation over the long term; decreasing my tax profile (taxes are my biggest expense) and sustainably increasing my standard of living.
Its funny how quickly the emotional side of being debt free is discounted by some. Sleeping well is worth tens of thousands. True enough, you can probably find investments that outstrip your mortgage interest rate. But that is just the numbers. Economic reality and decision making is about utility, and utility = happiness. Increasing wealth is offset by decreasing marginal utility. Being debt free provides its own utility that, for me at least, outstrips that extra 2% gravy I could venture in a risky market.
Some people, like myself, are just built different. Debt makes me worry. Worrying about money is a stressor on my marriage, one that I don't have. I want to know that I could continue living under the same roof, with the kids going to the same school, and able to wander next door to play with their best friends – if things go badly. If know that if I lose my job and have to get a lower paying one, my kids will be blissfully ignorant. I want to insulate them. Meanwhile I'm relatively indifferent to how nice my house is. In Austin, where I live, I could live in a $170k house or a $270k house based on my salary. The more expensive house is larger. It has designer appliances. But if I pick the right $170k house my kids go to the same (more or less) schools. Both houses have 2 car garages, a backyard, enough bedrooms for all, toilets the flush, and kitchens capable of the most daunting thanksgiving feast. Maybe my immediate neighbors aren't doctors and lawyers, but they are good people. Heck, I was able to get a good deal on some tile work precisely because my neighbor was a blue collar guy.
Same deal with cars. A lexus is nice. A corolla is only marginally less nice. Given free choice I'd choose the Lexus. Given the option between a corolla and or a lexus + $15k in debt, I'm taking the corolla. Those seats on the lexus are comfy, but its really just transportation.
Everyone's utility function is different. Some people really gain a lot of happiness from the bigger house. For me, solid middle class is pretty much fungible with upper-upper middle class.
Today is March 27, 2010.
The real estate market has crashed with no immediate hope of a rebound. Foreclosures. Short sales. Bankruptcies. Show of hands, please. Who wants to be debt free now? I figured this out and did something about it in 2002. Slept real good last night. When I woke up, Douglas Andrew’s infomercial was on the radio. It has been for the last several weeks. It was short on details. As best as I could figure he was pushing life insurance. Based on these threads it appears as if it is borrow against the house and buy life insurance. I don’t like debt and life insurance is not an investment. I’m glad I found these threads today. I won’t listen to his infomercial next week or any time in the future.
So what is so wrong about owning a house free and clear, living below your means, being debt free with hefty savings and investments? Looks pretty good right now don’t it? Yeah, I’m gonna sleep good tonite.