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URL:  https://boards.fool.com/hello-guys-thanks-for-the-replies-i-expected-a-29741584.aspx

Subject:  Re: Pull out equity for investments? Date:  12/22/2011  10:23 PM
Author:  JustMee01 Number:  8711 of 25816

Hello guys,

Thanks for the replies. I expected a debt-averse response from this crowd, so I’m not surprised I got it. As I said, I have an aversion to debt as well. But, I’ve come across the argument more than once that a 30 year mortgage product may actually be preferable at the moment to a 15 year product. And when you think about it, it makes some sense. The historical returns of the market beats that 4% 30 year rate easily.

Perhaps the better solution is one that came to mind from Denny’s response:

“I would refi the house at a lower rate. Put the money you save into your portfolio.”

Perhaps the 30 year refi with no cash out, rolling the extra cash saved per month into the market is the wisest course of action.

Some thoughts and replies to others:

@Denny: “BTW, rates are low and as soon as they pop, the bonds drop.”

That’s obviously true, in terms of mark to market. It’s probably also the case for NLY. But, it doesn’t affect the bond yield. Nor, does it affect their value if you’re holding to maturity. The port would maintain its positive 2% carry despite any market fluctuation of bonds within in. Besides, if rates were to rise, it would most likely be because of an improving economy. Equity gains would be expected in that case. That would probably end up a net push. PEP, AFL, KO and friends will be trading higher than their current levels if the Fed found enough of a reason to begin rate hikes.

@CM001: “Assuming you go with 4% mortgage and 6% yield portfolio, on a $100K port you are looking at $2000 per year before taxes. For me there is not enough return for the risk.”

This is a good point. Although, all it’s looking at is income. It ignores capital gains. With equity in the mix, the total return will undoubtedly exceed that return over the long term. But, it brings up a really good point. Is a couple grand worth it? Instead of refinancing and pulling equity out, refinancing to a 30 year adds $400 per month to savings. That’s about $5K extra pushed into the market per year. Perhaps that’s a better option than increasing leverage. You also have the added benefit of a boost to cash flow, which could be advantageous if anything unpleasant occurred, we needed a car, etc.

@Spock: “without knowing the sustainability of your current income, your investment results for the past 10 years, your plans for moving and such, and your spending habits I think most of us are going to frown on debt of any kind.”

Income sustainability is as certain as anything could be. You can never say never. Anyone can lose their job… But, things are actually quite good in that department. I won’t share personal details on the internet under any circumstances, even on trusted sites. It’s not you I don’t trust; it’s the rest of the world. ;-) Everything typed is there forever, for all eyes to read. So, I’ll dance around actual numbers to give you a feel. Income is six figures. Our savings rate is 30%. All of that is pushed into the market. Cash is kept minimal, but covers six months expenses.

The current mortgage is less than a year’s income. We control our expenses well; we’re both cheap to be frank. Cars are bought with cash. Credit cards are used for record keeping purposes, but no balances are carried. We actually have room to cut expenses, as we’ve been remodeling a 100-year old house the last five years. (Almost done, knock on wood. Something is likely falling apart as I type, LOL.) On the downside, the kids are reaching the age where they become more expensive. There is no chance that we’ll be moving in the next decade, and the 60% equity estimate on the house is an underestimate calculated off original cost. A lot has gone into it and it has appraised for more post-housing crash. (Our location was not really affected. Prices have held constant and demand is even decent.) Our retirement funding is on track.

@Hockeypop: “3. Do you have an emergency fund that equals at least the net yearly salary of the higher earning spouse?”

Do you mean cash? That seems excessive. I can accept the need for a rainy day fund, but I have a hard time justifying giving that much money to a bank at 1% interest. As far as liquidity risk is concerned, I can get money just as fast by selling some BRK as I can by going to the bank. In that sense, liquidity is fine. Cash is six months of expenses.

The kids’ education is not paid for. They aren’t there yet. That’s why we’re saving money of course. Retirement is on track, with the assumption of 10% returns going forward, even with no additional investment. I can say with certainty that a lot more money will be invested. We push 30% of our income in per year. It’s just that those extra funds will be in large part devoured by college, as you well know. That actually brings up another benefit of a thirty year mortgage. I’ve read more than once that having a mortgage is a net benefit in terms of financial aid, and that you shouldn’t own your home outright when they’re entering college. (Could be an urban legend…) Anyway, while we aren’t particularly young, our kids are. The house will be paid off before the youngest is in college, and a refi would push that out beyond her timeframe.

I think the real advantage of the port would be to take some cash out of home equity and get it to work. Someone responded that we could see additional downside for the market in the near term. I’d agree with that, but it really wouldn’t impact this hypothetical situation. Most equities chosen are long term assets in blue chips, and there’s no need for this income to make it work. We retain 30% of our cash as it stands right now, and the mortgage payment would not change. It would just get kicked down the road an extra 15 years. There is little chance in my mind that 10 or 15 years from now, companies like PEP, KO, PG, JNJ, and AFL will be trading at a loss relative to today’s prices. And thirty years from now, I suspect that $100K invested in these companies will be worth considerably more than the initial investment. As for the bank preferreds, I can see why some are hesitant. But, the point with throwing out those securities was to initiate the dialog. It’s a what-if list to show that you can piece together a 6% port without crazy corporate risk (JPM and Wells are healthy; one can debate that point with BofA), while including equities in the mix to diminish your interest rate risk. You don't need to reach for an excessive amount of junk to do it. That was the point. Thanks for the feedback. I’ll have to think it through.

Peter
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