Should I put my home equity in my PP?

[jason]

Hello all,

I have a PP with about $5.2 million in it (98% of which is in taxable accounts), and I have about $1 million in equity in my home.  That represents everything I have - I do not have a VP.  Should I refinance and pull the equity out of my house and put it in my PP?  Based on historical performance, the PP has performed a lot better than real estate with a lot less volatility, and mortgage rates are extremely low right now.  With my kids in private school and my fairly expensive lifestyle, I am spending about $250,000 per year, total.  At the same time, my work income is dropping rapidly due to the business I own performing poorly.  To be conservative, I want to plan ahead as if my business is going to close, so that extra million dollars in the PP would make a huge difference in how much I can allow myself to spend each year.  Spending $250,000 per year is 4.8% of my current PP, which is too high to be safely sustainable, so I would have to modify my lifestyle and reduce my overhead.  Putting the extra million in my PP would bring that down to 4.0%, which is still a little high, but borderline OK, and I think I can live with it and not really have to change my spending/lifestyle.  But the main thing holding me back from doing this is that I live in Florida and, due to the homestead exemption, the equity in my home can't be touched by creditors (not that I ever plan on defaulting on a debt, but you never know what the future holds), so it's kind of hard to give up that kind of asset protection.  I am having a hard time weighing the pros and cons, and any input would be appreciated.

Thank you,

Jason

[rickb]

If you take $1M equity out of your house by refinancing you have to add a mortgage payment to your expenses - and it sounds like you're not considering this.  At 3% (which I suspect is not possible), a 30 year loan is a little more than $50k/yr (PI) while a 15 year is nearly $83k/yr so presumably your expenses would rise to at least $300k/yr.  $300k is a little more than 4.8% of $6.2M - so unless you're willing to move to a house that costs $1M less then your current house (turning your equity into actual cash rather than rolling it into a loan) it sounds like you're no better off. 

[Ad Orientem]

I would say no. But I also have to confess to an almost neurotic phobia of debt. So I may not be the best person to ask for balanced advice on this subject.

[jason]

If you take $1M equity out of your house by refinancing you have to add a mortgage payment to your expenses - and it sounds like you're not considering this.  At 3% (which I suspect is not possible), a 30 year loan is a little more than $50k/yr (PI) while a 15 year is nearly $83k/yr so presumably your expenses would rise to at least $300k/yr.  $300k is a little more than 4.8% of $6.2M - so unless you're willing to move to a house that costs $1M less then your current house (turning your equity into actual cash rather than rolling it into a loan) it sounds like you're no better off.

I should have noted that I still have a mortgage.  I refinanced a few years ago to get a lower rate, so I refinanced just the remaining balance on my mortgage which was around $350K at the time.  My current mortgage with insurance and taxes is around $4,000 per month, and I think that would increase to about $7,000 per month or so if I refinanced and pulled out the equity.  So, you're right, I would be paying out around an extra $40K per year towards my mortgage, so it's kind of a wash.  But we also have to keep in mind that the mortgage interest is tax deductible, so a bigger mortgage equals a bigger tax deduction.

Thanks,
Jason

[sophie]

There are no guarantees that the PP will outperform your mortgage rate, so refinancing would be a bit risky.  The 30 year jumbo rates are up near 5% at the moment, so even with the tax deduction it could easily be a losing bet.  Not to mention that you shouldn't count on that tax deduction not going away.  Even if it is preserved there will likely be an income or home value cap in the near future.

If I were in your situation, with uncertain future income and a $5.2M nest egg, I'd seriously consider at least plannning how to reduce expenses to fit your current savings.  There must be places to cut from that $250K in annual expenses that won't limit your lifestyle.  Personally I can't imagine spending that much even with a couple of kids in private schools.

[Pointedstick]

Cutting your expenses is a good idea IMHO. A 250k/yr expenditure level is bound to be full of low-hanging fruit. Another thing you could consider is selling your business for some cash before it collapses on its own (in the worst-case scenario). You could plow the proceeds right into your PP. Doing the kind of work that would make it attractive to investors or possible owners could pay off very well if you chose this course of action.

[Tyler]

Arbitraging interest rates is small potatoes compared to sustainably reducing your outflows.  As others have said, I personally would start with thinking creatively about how I could cut back expenses. 

That said, from a withdrawal rate perspective you also should factor in that your fixed duration expenses will eventually go away.  For example, unless you plan on keeping a mortgage and paying for private school for at least 30 years (or you plan to immediately spend that money elsewhere as soon as the debt is paid off) you really shouldn't include them in traditional withdrawal rate calculations. 

On the simple side, what happens to your withdrawal rate if you only focus on the spending you intend to maintain forever and discount your total mortgage/school commitments from your current savings?  Combining two ideas, would selling the business cover your fixed duration commitments?  Then you'd have the same (or greater) nest egg with substantially lower sustainable expenses to account for without changing your lifestyle. 

[moda0306]

I haven't scanned every comment, but I don't think you get to deduct debt from taking a cash-out refi/mortgage.  It has to either be acquisition debt, refinance of that debt, or home improvement debt.

So you get no tax-deduction... I'm quite sure.


Regarding the idea, I'd only do it if long-rates on t-bills were higher than my net-borrowing cost.  If I KNOW that half of my PP is losing to the debt, and half of the rest is a shiny yellow metal that is extremely volitile in value, It would be hard for me to justify the strategy you're referring to.

However, a few things to think about are:

1) Is there any way through a SEP and Non-deductible Roth IRA's, or your wife's job/business, to start cramming money into tax shelters? 

2) Have you considered your plan with Social Security?  If you are a) healthy, and b) have lots of other funds, the 7%-8% (plus inflation) adjustment to the payout, and the fact that the higher payout of your two SS checks will remain as a joint benefit, then deferring that higher SS check until 70 should be considered.

[moda0306]

I haven't scanned every comment, but I don't think you get to deduct debt from taking a cash-out refi/mortgage.  It has to either be acquisition debt, refinance of that debt, or home improvement debt.

So you get no tax-deduction... I'm quite sure.


Regarding the idea, I'd only do it if long-rates on t-bills were higher than my net-borrowing cost.  If I KNOW that half of my PP is losing to the debt, and half of the rest is a shiny yellow metal that is extremely volitile in value, It would be hard for me to justify the strategy you're referring to.

However, a few things to think about are:

1) Is there any way through a SEP and Non-deductible Roth IRA's, or your wife's job/business, to start cramming money into tax shelters? 

2) Have you considered your plan with Social Security?  If you are a) healthy, and b) have lots of other funds, the 7%-8% (plus inflation) adjustment to the payout, and the fact that the higher payout of your two SS checks will remain as a joint benefit, then deferring that higher SS check until 70 should be considered.

That is incorrect. The interest on a mortgage secured by your primary residence is fully deductible under current tax law, regardless of the reason for the loan.

Moda, IIRC from previous posts, aren't you a CPA?

Yes I am. I however spend very little time nowadays with the details of the individual tax code anymore.

You are right about the debt being deductible... however there are a couple things to point out...

First off, debt taken on a home for purposes other than to buy or substantially improve a home is limited to $100,000 of principal. Everything above that is not deductible.

This is from the IRS publication on home mortgage debt deduction.

-----------------

Home Equity Debt

If you took out a loan for reasons other than to buy, build, or substantially improve your home, it may qualify as home equity debt. In addition, debt you incurred to buy, build, or substantially improve your home, to the extent it is more than the home acquisition debt limit (discussed earlier), may qualify as home equity debt.

Home equity debt is a mortgage you took out after October 13, 1987, that:

Does not qualify as home acquisition debt or as grandfathered debt, and

Is secured by your qualified home.

Example.

You bought your home for cash 10 years ago. You did not have a mortgage on your home until last year, when you took out a $50,000 loan, secured by your home, to pay for your daughter's college tuition and your father's medical bills. This loan is home equity debt.

Home equity debt limit.  There is a limit on the amount of debt that can be treated as home equity debt. The total home equity debt on your main home and second home is limited to the smaller of:
$100,000 ($50,000 if married filing separately), or

The total of each home's fair market value (FMV) reduced (but not below zero) by the amount of its home acquisition debt and grandfathered debt. Determine the FMV and the outstanding home acquisition and grandfathered debt for each home on the date that the last debt was secured by the home.

-------------------



Further, if someone is in AMT, and don't use the money to buy, build, or substantially improve the home, it is technically not deductible for AMT purposes. 

http://www.amtadvisor.com/AMT_adjustments.html

So this was what I was misremembering.

[clacy]

I'm not a financial planner, so I can only advise you based on what I would do personally.  I am a family business owner/operator, in an industry with a low profit margins, so a failing business scenario is something that I've given a fair amount of thought and even taken planning steps to prevent a worst case situation some day down the road.

Especially given the fact that you are a FL resident, I would certainly not touch your home equity to move into the PP.

I still believe the PP is a sound strategy for holding a high percentage of one's assets, and I don't foresee it ever having a 25%+ draw down, but I certainly wouldn't be shocked if we saw a "lost decade" where the PP hovers around a 0% real return.

Especially given that you're a business owner that likely has many creditors, customers and employees that could decide to sue you at any time, I would keep your $1m in equity.

Considering you are a high income business owner, you could very likely earn a nice income by getting a job if needed down the road.  If you earned even $80-100k/yr working a job, and reduced your expenses slightly, you could probably weather almost any scenario, and not have to withdraw too much of your PP or home equity.

[Larshus]

I'm in the same boat-ish. I own my home free and clear and have often thought of financing it with the extremely low current rates... Until my late father's voice starts screaming at me that I'm a moron. His point would have been that with 3 kids, I'd be a fool to give up a completely risk free scenario (I own the house) for one where I take on risk for marginal benefit. Lets be realistic.. we are not going to make 10-20% on the spread here. The risk/reward ratio is terrible. One good outcome (make a few extra percent) and myriads of bad ones.

The op is slightly different as I take that hes older AND its in Florida (homestead). If he's uncomfortable with the equity in the house I suggest the following:

1) Do nothing, live with the risk free scenario.
2) Downsize the house, move into something that you have no mortgage on, stuff the excess cash into the PP
3) Stay in the house, cut your monthly expenses.

[dragoncar]

4) Sell the house.  Move into a slightly smaller house.  Finance the new house and put the proceeds from the sale into the PP.  Deduct the entire mortgage.

Although, twere it me, I would just pay off the mortgage and reduce my expenses to fit within 3-4%

[ns3]

Sounds pretty close to a violation of HB's Rule#7 to me.

Personally, if I had a house that was paid for I would leave it paid for and if I had (I have) a house that was not paid for I would not take any extraordinary measures to pay off the mortgage unless it had a high interest rate (and maybe not even then).

On a side note I think it is not a good idea to state one's net worth on the forum and I've noticed that those who do tend to be multimillionaires.
I freely admit that one reason I don't like this is because it makes me jealous but also I think it might give readers of the forum the impression that the PP is a rich man's investment strategy (and that might very well be true, depending on one's definition of rich).

[dragoncar]

Sounds pretty close to a violation of HB's Rule#7 to me.

Personally, if I had a house that was paid for I would leave it paid for and if I had (I have) a house that was not paid for I would not take any extraordinary measures to pay off the mortgage unless it had a high interest rate (and maybe not even then).

On a side note I think it is not a good idea to state one's net worth on the forum and I've noticed that those who do tend to be multimillionaires.
I freely admit that one reason I don't like this is because it makes me jealous but also I think it might give readers of the forum the impression that the PP is a rich man's investment strategy (and that might very well be true, depending on one's definition of rich).

Eh, it's obvious we have a mix.  One guy was recently worried about rebalancing when he could only buy gold in $1k increments or something like that.  I'm obviously jealous of the high net worth posters, but it's also nice to see that successful people buy in

[jason]

Sounds pretty close to a violation of HB's Rule#7 to me.

Personally, if I had a house that was paid for I would leave it paid for and if I had (I have) a house that was not paid for I would not take any extraordinary measures to pay off the mortgage unless it had a high interest rate (and maybe not even then).

On a side note I think it is not a good idea to state one's net worth on the forum and I've noticed that those who do tend to be multimillionaires.
I freely admit that one reason I don't like this is because it makes me jealous but also I think it might give readers of the forum the impression that the PP is a rich man's investment strategy (and that might very well be true, depending on one's definition of rich).

I appreciate all of the advice from the forum members.  I apologize for using real numbers - I certainly didn't mean to create bad feelings.  I just figured if I didn't use actual numbers, I wouldn't be able to get optimal advice.  And since it's such an important decision for me to make, I didn't want to leave anything to chance. 

I would like to emphasize that using the PP has nothing to do with how much money one has.  If I had $10,000 in savings, I would still be using the PP.  The PP is all about finding the sweet spot in the risk/reward balance.  As far as I know, the PP provides the best combination of high reward/low risk, with the additional benefit of insurance (via gold) in the event of an economic collapse.

[ns3]

I appreciate all of the advice from the forum members.  I apologize for using real numbers - I certainly didn't mean to create bad feelings.

No bad feelings except for jealousy over your success which shouldn't bother you at all. That's our problem, as many of us who have it.

Bottom line though, if you're talking about borrowing money so you can maintain your current lifestyle which, correct me if I'm wrong, seems to be the gist of it - I think most of us PPer's would say that is a bad idea and you ought to figure something else out.

[Laker]

I do not think higher worth posters should not post amounts, it makes the discussion more valid. If we don't fully understand the situation, it is hard to make recommendations. I appreciate this particular topic as I have considered it as well, although I have less and am probably older and less wise.