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If you had enough money to pay off your mortgage right now, would you? Many people would. In fact, the ‘Canadian Dream’ is to own your own home, and to own it outright, with no mortgage. If the Canadian Dream is so wonderful, how can we explain the fact that thousands of financially successful people, who have more than enough money to pay off their mortgage, refuse to do so.
The answer? Most of what we believe about mortgages and home equity, which we learned from our parents and grandparents, is wrong. They taught us to make a big down payment, get a fixed rate mortgage, and make extra principle payments in order to pay off your loan as early as you can. Mortgages, they said, are a necessary evil at best.
The problem with this rationale is it has become outdated. The rules of money have changed. Unlike our grandparents, we will no longer have the same job for 30 years. In many cases people will switch careers five or six times. This means we can no longer count on a company pension to provide a good income for our retirement.
Given these statistics, more middle class homeowners are choosing to use their mortgage as a tool just like the wealthy — those with the ability to pay off their mortgage but refuse to do so. Will you be one of those who create a new, liquid, financially secure dream?
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Your home is more than just a place to live — it’s also an investment that can help you build wealth. Owning a home has been the single most effective way for many Canadians to increase their net worth. Managing that wealth presents unique challenges, but can lead to financial opportunities that only come with home ownership.
Overcoming the compulsion that many consumers feel to pay down their mortgages as quickly as possible can only be achieved by gaining a working knowledge of how to harness these various components together to ensure consistent returns on equity investments. Diligent investors nurture their portfolios of stocks, bonds and mutual funds. But most homeowners do not give the same care to managing what is typically their largest investment–their home.
In 2003, financial planner Douglas Andrew was the first to articulate the strategy the wealthy have been using for decades. In his book, Missed Fortune, Doug educated his readers to view their mortgage and home equity through a different lens – the lens used by the affluent. In Missed Fortune, Doug suggests that people strongly consider separating as much equity as possible from their home. The three primary reasons are the same test an investor would consider in making a prudent investment:
1. HOW LIQUID IS IT?
2. HOW SAFE IS IT?
3. WHAT RATE OF RETURN CAN I EXPECT?
How does the equity in your home stack up against these three tests?
As a homeowner it is easy to forget that Home equity is typically the least liquid investment you have and the only investment that requires you to qualify to access your wealth. When you need it most, you may not have it and you may not be able to qualify for a mortgage to get it. Remember, most lenders are income lenders, not equity lenders. They want to know what ability you have to pay them back the money you want to borrow. The best chance of you being approved for a loan or any line of credit is when you do not need one.
All right you say, but it is save sitting there in the brick and mortar (or wood frame) of my home. Unfortunately it is not as safe as you think. What happens if real estate values go down in your area? Well, your home equity goes down accordingly. What if a disaster hits your home? Yep, once again you face loss or at least temporary loss of your home equity. What about a personal disaster like sickness or job loss? If you have a mortgage your equity is not at risk. Banks don’t care about those types of personal problems; they only want their monthly payment. The truth is that home equity is at risk from a variety of sources.
What is the rate of return of home equity? Most people will confuse the rate of return of home equity with the increase of value of their home. In fact these are independent items. Your home appreciates the same whether you have a large mortgage on it or it is mortgage free. The answer to the question of rate of return on home equity is 0%. That’s right all that home equity you have built up is languishing in a savings account getting 0% interest!!
This is why forward thinking folks suggest you separate your home equity (some call it liberate) from your home. Now, many folks take out home equity to spend. If this is your intention, then you are better off leaving it in your home for a forced savings account. However, for those folks who have the discipline to put the home equity into a savings/retirement vehicle this is a no-brainer.