This is a good board with a lot of smart folks on it. I'd like an opinion.How sane is this? We have a 15 yr. mortgage in the 4.5% range, and over 60% equity in our home. We refinanced a couple of years ago for a new roof and siding. The house is in pretty good shape in terms of repairs, etc. I’ve been watching mortgage rates dip and dip and dip and thinking about refinancing again, just for the savings, however minute. (We pay more in NYS property taxes than we pay on our mortgage.) But, now that I see quotes below 4% on 30 year mortgages, I’m considering actually taking some equity back out and getting it into the market. I don’t think it’s that hard right now to build an income oriented port that’s conservative and yields well north of that ridiculously low 30 year rate.Consider:NLY 14%JPM TruP 7%WFC TruP 7%BAC TruP 8%BAC pref 9%Ford bonds 7%PEP 3.2%AFL 3.2%PAYX 4.3%ADP 2.9%KO 2.7%PG 3.2%JNJ 3.6% That 13 position port, scratched together without much thought can yield around 6%. With some thought applied, I think I could put together a reasonably “safe” port that yields north of 4%, with a combination of fixed income and equities to offset some of the interest rate risk.Normally, I wouldn’t even consider increasing leverage. We’ve only done it once as a matter of fact, to take advantage of low rates for large repairs to the house. (We even try to avoid car loans.) But, rates are so low, it seems like one of those once in a lifetime opportunities to take advantage of. The kicker is that we could switch from a 15 year to a 30 year, pull out 100K in equity and have virtually the same mortgage payment as our current 15 year. So, we would remain well within our cash flow constraints, even excluding the income from this hypothetical port. Income off the port can roll back into the mortgage to reduce principal, if desired, or Drip back into the port, whichever makes more sense at the time.Does that sound nuts to anyone? Or to everyone, LOL? I know that leverage is a big sin in the stock market. At least I see it as one. I never buy on margin, don’t short, can’t get myself to consider options… I'm really pretty conservative with 90% of my port. Admittedly, the other 10% ijn the playpen can get kind of overadventurous...Anyway, a big segment of that quickly assembled port consists of dividend aristocrats; some of the most predictable companies around. Is it time to buy some of Buffett’s “equity bonds” with some historically record cheap capital drawn out of home equity? Or am I potentially stepping in it? Thanks for any thoughts…Peter
NLY 14%JPM TruP 7%WFC TruP 7%BAC TruP 8%BAC pref 9%Ford bonds 7%PEP 3.2%AFL 3.2%PAYX 4.3%ADP 2.9%KO 2.7%PG 3.2%JNJ 3.6%
Nuts, nuts, nuts! LOLAs you state, the problem is leverage. It bites you when you are most helpless. Leverage gives you an "efficient" portfolio but not a "secure" portfolio.I would refi the house at a lower rate. Put the money you save into your portfolio. But don't put your house eggs into the portfolio basket. Keep them separate.BTW, rates are low and as soon as they pop, the bonds drop.Anyway, that's what I would do.Denny Schlesinger
That 13 position port, scratched together without much thought can yield around 6%.my presumption with a portfolio like this would be that you are an expert on bank/financial balance sheets, loss reserves, and the like, right? Otherwise, you make a whole lot of great points but 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. Doesn't mean much, but I have a track record myself but have never flinched at getting rid of the mortgage as soon as possible, believing there is a tangible benefit to not being beholden to anyone else. Call it my Dave Ramsey moment, but it seems like you are a smart guy who saves a lot and knows how to manage your finances really well so why bother with the added risk? Besides, 2008-2009 showed that 'safe' is in the eye of the beholder, but maybe you cleaned up during that period and it didn't bother you to see stocks down 50% and more over a 6 month period. Did me.
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 the for the risk. If sp500 @ 700 and you feel compelled to make that I can understand. But where the market is now and potential macro issues like possible recession, Euro blow up, China melt-down, etc can easily cause the markets to go down by 15-20%. If you do the risk reward on such scenario, I would prefer to sleep better rather than take that risk.
How old are you? If over 50 -- NO!If under 50:1. Is the rest of your retirement plan complete or ahead?2. Have you paid for the children's education?3. Do you have an emergency fund that equals at least the net yearly salary of the higher earning spouse?4. Are both jobs secure?5. Is everyone in the family healthy and likely to remain healthy?6. Are you willing to commit that portfolio for 10 years (and I'm not wild about all those banks)?While BOTH arguments posted previously saying NO are good, if you can answer yes to all 6 questions (and I may have missed some)and you're willing to gamble a little, I'd say yes. You know, the biggest problem MAY be if this succeeds. Using housing leverage to pay for things is how some very high salary people are underwater in their homes. I'd hate for you to make this a steady practice.But, most of my best investment lessons were unmitigated disasters (I keep my FUQI to remind me that I'm not too old to make mistakes, but I am smart enough not to bet essential money).Hockeypop
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
why not pay off the house and then redirect the former mortgage payment into investing?I have always been horrified at how much interest adds to your cost basis in a home. I hate paying to use someone else's money ie the loan. I want someone paying me to use my cash. maybe you should calculate how much 30 years of paying interest is going to add to the cost of your house? See how much you can save by not doing it. In fact, I would consider making 2 payments per month. This second payment goes to principle and your loan gets paid off double fast. We paid off a 15 year mortgage in 7 years. That lack of mortgage frees up a lot of investment dollars
1. Six months of expenses is too generic IMO, but it's not bad as a rule of thumb. Your problem is what happens if the higher wage earner gets run over by a bus -- and lives. That net may be six months of expenses, or not.2. Not cash only for the emergency fund, but readily available funds like breakable CD's, ST treasuries, etc. I know that's a hard emergency number when you're young ... but bad stuff happens.3. Actually I used a home equity line of credit for cash flow since about forever and reasoned that it allowed me to reduce my emergency fund. It helped with purchases where I KNEW I'd be able to make up the money. Dangerous -- but OK if disciplined. I also used it for the kids college education. Again, I saved enough for two years and my cash flow allowed me to finance the final two through current savings AND the HELOC. PS: You're right -- the home is exempt by formula from FIFA but your investments are not.4. Heck, at your saving rate, with kids, you should be teaching ME. Congratulations! The only thing I'd add is that AFTER kids, you have more money to put toward retirement than you can imagine. I keep a pretty tight budget, but kids cost in ways that creep throughout, and I've saved more than I thought. That LBYM habit is wonderful!!!!Got to run. DW has a few more things to get. Again, congratulations. It NEVER hurts to run ideas past these people. I LOVE to learn how their minds work.Hockeypop
Oopps--PS: There are AT LEAST 10 times in the last ten years when I would have HATED to sell Berkshire stock (and I'm a big owner too). That's part of the beauty and value of emergency funds too.http://caps.fool.com/Ticker/BRK-B/Chart.aspx?source=icasitta...HP
A large cash emergency fund is not a good idea. Prudent cash management reduces the need for one.First of all, one should have a credit card (or credit cards) with large credit limits. As long as you don't use the credit, it costs you nothing but you have it handy as a cash management tool.Second, one should have a margin account with the broker. Again, the margin costs you nothing as long as you don't borrow but it is there as a cash management tool for when you need it.Now that you have your tools lined up, here is how you use them. You pay everything you can with the credit card and pay it off monthly so as not to have any credit charges. I pay mine with an ACM transfer from my brokerage account. In an emergency you have lots of instant credit available. Should you have such an emergency, put it on the card and pay off the card with margin from your broker. The card credit (about 15 days) is going to be free. Of course, now you have margin debt and you should start pruning the portfolio to pare it down and it can be done in an orderly fashion.Better yet, don't have emergencies. LOLDenny Schlesinger
based on everything you describe, to me you are asking a very simple question - should I use a modest amount of leverage with my portfolio. Obviously the answer is up to you, but it sounds like it won't matter one way or the other. Still, if I were to advise someone on the logic of using margin, my answer would center on two basic things: your past track record (negelected in your otherwise comprehensive response, but to me it still appears like the most important variable - pls don't feel like I'm badgering you to mention anything you don't think is appropriate for a public BB) and your tolerance for declines. If your record is good and you don't mind the occassional drop, then go ahead and use it at your discretion.
Denny,Second, one should have a margin account with the broker. Again, the margin costs you nothing as long as you don't borrow but it is there as a cash management tool for when you need it.Now that you have your tools lined up, here is how you use them. You pay everything you can with the credit card and pay it off monthly so as not to have any credit charges. I pay mine with an ACM transfer from my brokerage account. In an emergency you have lots of instant credit available. Should you have such an emergency, put it on the card and pay off the card with margin from your broker. The card credit (about 15 days) is going to be free. Of course, now you have margin debt and you should start pruning the portfolio to pare it down and it can be done in an orderly fashion.With props to ALL the great contributions you make:1. Over 45 years of responsible work I've been out-of-work twice as the major breadwiner either totally unemployed or seriously under-employed for a year each time;2. I've been in a market in which I've had one REALLY serious margin call that seriously killed my investment portfolio through sales and high interest rates;3. Thank God they never happened at the same time. Just sayin ...Hockeypop
Just sayin ...HockeypopNo doubt, shift happens!How safe is safe? Each one of us has to find the sweet spot that let's one sleep well at night. Denny Schlesinger
Hello again,Something KitKat said set me to thinking again. She suggested that I calculate what we’d have to pay in interest over the life of the loans. I did that and was not pleased with the numbers, which I think was probably the intent of her advice.Rounding numbers to make conceptualization easier, I calculated the interest expense on a 15 year $100K loan, a 30 year $100K loan and a 30 year $200K loan. This third loan would essentially be the hypothetical case of taking out an extra $100K in equity.$100K @ 3.875% for 15 years: $32,019.08$100K @ 4.0% for 30 years: $71,867.92$200K @ 4.0% for 30 years: $143,739.21Those are some pretty big numbers when all is said and done. Then I thought about how much I would extend the payment, pushing it into years when we probably would not wish to have payments to deal with. We gravitate toward KitKat’s desire to not owe money to other people. At that point, the whole idea looked more hare-brained.However, in those simple calculations I wasn’t capturing the value of the port; the value of that $100K for thirty years wasn’t entering into the calculation. After all, what I’m really proposing to buy with that extra $100K is a set of securities; an asset. They need to be accounted for in some fashion.The easiest way to do that is to look at their cash flow and incorporate it some way. And thinking about that further, I realized that I’m more like KitKat than I might sound. I do see the value in not owing people money. My first response, if “stuck” with a 30 year mortgage would be to pre-pay on it. That provides another way of looking at the whole scenario. What if the proceeds from the port are applied to the mortgage, accelerating payment of the loan? This is after all, one of the more likely uses we’d choose for the money. The other would be to drip back into the port. This is not income that we need for any living expenses. Those are covered. So, let’s forget the drip and let’s use that income to prepay to see how the numbers work out.So, one more thought experiment: let’s incorporate that pre-payment into the numbers, and look at the numbers for that hypothetical $200K loan, with $100K used to purchase securities yielding an average of 6%. Assuming an interest rate on the loan of 4%, and a 30 year term, the monthly payment is $954.83. Six percent on $100K is $500 per month. If you do that, then the numbers look very different. First, the prepayments cut the life of the 30 year loan in half. The term becomes 15.5 years just by pre-paying $500 per month. If you total your payments over 15.5 years, you arrive at a total payment of $269,143.55 on that $200K loan. But, only $176,643.55 was out-of-pocket expense. The remaining $92,500.00 was paid off by the income stream from the port. You’ll have some out of pocket expenses for taxes that will reduce that some. You’d also have greater income expense to deduct from your income that would partially offset. They could be calculated. But, at the end of that 15.5 years, you have a clear title on your house and a portfolio that I’d wager is worth considerably north of $100K, for out of pocket expense of $177K. Accounting at cost, that’s $200K in assets, purchased for $177K, because you accelerated the amortization schedule with the captured interest spread. Plus, you have that port’s income stream in the future.Compare that to the 15 year $100K mortgage. At the end of 15 years, you have a clear title for your trouble and out-of-pocket expense of $132,752.64. That’s $100K in assets, purchased for $132K. From that perspective, I think you’re ahead on the larger loan; you’ve captured the interest spread on the “extra” $100K, and used it to pre-pay the other $100K in principal for the house. When I checked rates today, I actually found that they had ticked down. Thirty year rates are now under 4% from multiple lenders. Thanks for all the thought provoking replies. I’m nowhere near a decision, but the responses have made me think about it from different angles that I had not explored on my own.Peter
Peter,I just did the same thing that you are considering and close next week so this thread has been very interesting to me.In 2002 I bought a house built in 1878 that hadn't been updated since 1878...well maybe 1950. I gutted it and rebuilt it mostly in 2002 when we were dual income no kids. 2002 almost killed me...ha ha. I finished it off over the last 9 years (and 3 kids) and had a ton of sweat equity in it. I don't ever want to leave it and I don't see many scenarios where I will be forced to. I just refinanced to a 30 year loan which added 9 years more than I had on the old loan and that can be ugly when you look at amortization schedules, I know. But tax advantages and compounding do wonderful things too. I got 4.25% because I rolled all closing costs and escrow into the loan. I stayed under 50% loan to value to make the loan process easy (less than 3 weeks which surprised me), get the best rate and to keep my payments just under 20% of my gross income. I was very close to doing this in 2008 during the crash and didn't and I really regret not following through. Hindsight might bias that regret but I think it was pretty obvious at the time that I missed a twice in a lifetime opportunity. I don't see the current environment as opportunity laden as then but we are living in interesting times and opportunities might present themselves again. I'm not going to try to persuade you one way or another but in my situation I felt very comfortable with the additional leverage. Whether 4-4.25% float is cheap is another matter altogether. Best of luck to you whatever you decide.
NLY, a stock and company I love, is not part of a "conservative" portfolio. That 14% yield comes with the understanding that one knows in the future the spread will shrink and perhaps invert, tumbling the dividend and causing a steep decline in the stock price. Farrell has proven adept at dancing the company thru those hard times, in part by limiting the leverage to "only" 8 to 12 times, and in part by employing a "dumbbell" strategy (read the 10K's for an explanation).I buy NLY in my IRA every year, but I don't pretend that this is a conservative part of my portfolio.RWS
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