Don’t Rush To Pay Off Your House

For the majority of African Americans a house is their biggest asset.  As such it is thought to be the single most important aspect when it comes to wealth building, particularly in the African American community.  We have been told all our lives to “buy a house and stop wasting money on rent.”  Well the advice is good does make sense in theory there are some flaws associated with it, depending on your situation.  While home ownership is definitely worthwhile for many people, paying off your home may not be such a wise thing to do.  Let’s take a look at some of the flaws…

Remember sitting at the closing table and having a stack of papers placed in front of you to sign?  Didn’t it feel as though you were signing your life away?  You have just ensured that you will have a debt that will last you the next 15-30+ years of your life.  Naturally you may start to think “how can I pay off this loan in the shortest amount of time possible?” 

Flaw #1 – choosing a 15 year or biweekly mortgage.

These loans essentially have you making a higher payment or extra payments every year.  For example, with the biweekly mortgage, as opposed to paying 12 monthly payments you make 13 payments (biweekly mortgage) with the extra mortgage payment composed of pure principal. Doing the math you see there are 52 weeks in a year, divide that in half gives you 26 biweekly payments, which is the same as 13 monthly payments.  Got it? Good.

The problem with these mortgages is that by shortening your loan period you increase your monthly debt (higher mortgage payments) and decrease your tax deduction.  Since a greater portion of your loan payment is going to principal, less money is going to the interest payment, thus the faster payoff.  So at tax time your “mortgage interest deduction” will be smaller meaning you will pay more in tax than you would otherwise have to.

Don’t forget that a “paid off” house still has a insurance and tax payment due every year.  You are simply eliminating the principal and interest portion of the payment.  I know what you are thinking …”by paying off my mortgage faster I save thousands in interest.”  Again for some people this may make sense not realizing that the flip side to this is “you lose thousands of dollars in interest” as well.  In the world of investments this is known as opportunity cost.

Simply stated opportunity cost says that for every decision we make there is also a decision that you are not making.  For example, imagine coming to a fork in the road while driving…which way do you go?  By choosing to go right you have given up the opportunity to go left.  I know its simplistic by just follow me.  By choosing to pay your extra money towards paying off your  mortgage you are also choosing to not put that extra money someplace else (i.e savings account, retirement plan, etc).

Studies have shown that by taking the difference in monthly payment between a 30 year and 15 year mortgage and saving it in a disciplined way over the same time period, you actually can come out ahead after the same time period.  Most important is this…you always have access to the money (i.e. liquidity).  The average American moves every 5-7 years, so chances are you will have paid more into a house that you will not be living in 15 or 30 years from now.

Thus it can make sense to lower monthly expenses, save the difference and increase the tax deduction.  This is accomplished by choosing and keeping a 30 year mortgage (typically the lowest fixed payment available) for the rest of your life.  In our current economic environment, with people losing jobs and foreclosures rising, a lower fixed monthly mortgage payment is a good thing.

The second flaw – thinking your house makes money.

We all know that most houses tend to appreciate in value over time even though many have decreased in value lately.  The difference between the market value of your home and the existing mortgage balance is known as equity.  However the mistake that many people are disillusioned by is thinking that “equity” makes money (i.e. earns interest).  Ask yourself this question “what was the rate of return on my house last year?”  I already know the answer….zero.

For many you probably feel it was even negative.  You see a house (equity) does not earn a rate of return, either positive or negative.  The appreciation on a house is driven, in essence, by your neighborhood (location), housing market and interest rates.  Have you noticed that home prices will increase when interest rates decrease?  Or that a foreclosure in your neighborhood brings down the value of your home?  Again there are no interest on home equity.  It is all market driven.

Keep in mind that most houses will appreciate or depreciate whether they have a mortgage or not.  Not to mention that a house is also very illiquid as an investment anyway.  Look at how many people owe more on their house than it is worth and can not sell.  And how many people had their home equity lines of credit reduced or cancelled?  Retirees that need money and have their houses paid off end up “borrowing” money back out of their houses (i.e.. reverse mortgage) in order to maintain their standard of living or to pay for unexpected medical costs.

This is a perfect example of becoming “house rich and cash poor.”  People who had homes that they were rushing to pay them off found that not having that extra money available may have cost them not only their homes but their financial futures as well when the real estate bubble burst.

The third flaw – thinking your house will continue to appreciate indefinitely.

Recently we’ve experienced the lowest interest rate environment in over 40 years and as a result we had seen tremendous growth in the value of homes.  But what happens when interest rates increase…the value of your home may actually decrease!  In the past, many home buyers could afford the higher priced houses simply because interest rates were low, which meant that their mortgage payments were low (more affordable).

When interest rates increase, the same house may become unaffordable simply because the monthly mortgage cost increases as well.  This is what caused the collapse in the real estate market.  Homeowners who saw their mortgage payments increase as a result in the rise in interest rates found they could no longer make the higher payments.  Now sellers are forced to discount the price of their homes in order to make it more affordable to a buyer who is now forced to finance at the higher interest rates.  See how you can lose equity through no fault of your own?

The recent real estate market is one example what can happen as millions of people have seen their home equity completed wiped out completely and have been forced to sell their homes below what they are worth.  You see a person with a mortgage today is probably upside down AND the person with the paid off house also has seen their home go down in value as well.  You may say what does that matter if my home is paid off?  You must bring the story full circle.

Since many African Americans believe home ownership is a foundation of wealth creation (evidenced by Black Enterprise’s Wealth For Life Principles) you must envision the potential role your home will play in your future.  The person with the paid off house may one day look to sell the house and use the proceeds to buy another house (downsizing) for retirement.  My parents sold their house prior to moving down south for the warmer weather and cheaper homes.  They used the proceeds from the sell as a down payment on their retirement home.

What if the house you want to sell is down in value and you don’t get what you are expecting for the home….change of plan for retirement!  Maybe you are an older person needing some extra money to support yourself and someone recommends a reverse mortgage.  Well one of the tenets of a reverse mortgage is the value of your home.  If the home is down in value the amount of money you can receive for the reverse mortgage has also gone down.  Perhaps you just simply want to use the proceeds of the sell of your home to live off of or fund your retirement.  The circle continues….

In closing I hope you realize that while everyone’s situation is different, having  money available (liquidity) and not trapped inside your house is not such a bad thing.  A prudent strategy for its usage will trump simply following conventional wisdom.  Paying off a mortgage at the expense of keeping money available to you perhaps requires a second look.  After all a bird in hand….you know the rest.

Willie Lynch Still Alive and Kicking…

“If you take a slave, if you teach him all about your language, he will know all your secrets, and he is then no more a slave, for you can’t fool him any longer, and being a fool is one of the basic ingredients of an incidents to the maintenance of the slavery system.”

So I just found myself having an interesting conversation with my wife.  It came as a result of my asking her for an opinion on a financial newsletter I am currently working on.  (In case you were wondering I am a financial advisor by trade.)

So long story short, she reviews the newsletter then says that she feels it is too long (mind you it only consists of two stories thus far).  Anyway I asked her why she felt that way and she says “I just don’t like to read…it needs to be shorter.” Ahhh, thus a problem has reared its head once again and this time in my own household.  Not to sound too stereotypical or jump to conclusions but what is it with African Americans and reading?  This is a thought I have have had in the past and obviously just my personal experience.

I know this is just my wife and she could have just simply not been in the mood to read it but the underlying theme remains. I have run into this situation in both my personal life and in my practice.  Yes there are times when I ask clients to read books,  sometimes simply for education and other times to help reinforce a better understanding of a strategy we are currently implementing.   Perhaps its simply because its just a good book to read.

I recall a saying I heard not too long ago that is simply stated but seems to hold very true in nature “if you want to hide something from black people…put it in a book.”  When I became a reader I was amazed not only with how much I was learning but also by how much I was misunderstanding.

Thus the Willie Lynch reference.

For those not aware Willie Lynch is the story of a slave owner from Virginia in 1712 who gave a speech in which he outlined rules he established for other slave owners on how to make sure slaves always remained slaves (both in body and mindset).  The rules were more or less an instruction manual as to how to keep slaves from thinking for themselves, plotting against one another because of skin color and keeping them from becoming educated.  The latter is the one I would like to talk about.

Don’t get me wrong my wife is highly educated having completed a doctorate in Dentistry but the mindset is what gets me.  What is it about reading?  We all know what it is…In our culture we have been brainwashed to receive all of our information from mainstream television, radio and now the internet.  (Don’t get me started about BET either…that is a upcoming blog all to itself).  But whatever happened to simply picking up a newspaper, magazine or book and simply reading every now and then.  Its no wonder we are raising a generation of children that only wants to sit in front of the television all day, play video games and does not go outside and play.  Illiteracy and obesity are huge problems in the black community and it is happening at younger and younger ages.  Simply look at the numbers for juvenile diabetes in the African American Community.

African Americans both young and old realize that education is the key to our future but we don’t emphasize this in our culture.  Reverend Al Sharpton was in Washington, DC this past weekend to bring light on the fact that the school system is still separate and unequal 55 years after the passage of Brown v. Board of Education.  The writing is on the wall and since we don’t read we don’t even notice it.  The number of people that showed up to support Reverend Sharpton was an embarrassment to our culture given the importance of the message he was trying to convey.

But let’s get real we don’t care anymore.  Yes you have those who are in the trenches fighting the battles but its the war that needs to be won and quite frankly there are not enough soldiers.  If the problem isn’t in your household then it is someone else’s problem.  I recall it once being stated that it takes a village to raise a child…that was a long long time ago.

We have over 300 million people in this country and a few thousand (if that) showed up to voice concern and show support for the equal opportunity for education of our children.  African Americans need to realize that no one else will care more about our children, culture and well being than we will.  Until we realize that we are all in this boat together and everyone needs to paddle we will continue to be disenfranchised in the educational and financial system and Willie Lynch will remain with us for years to come.

Welcome

Welcome to my new blog.  Off the back you are probably wondering why it is entitled “Black Opulence.”  Well I thought it was a really good name and it sounded fairly extravagant.  Opulence is defined as wealth, riches or affluence.  In a nutshell this is a blog geared towards educating and empowering African Americans to become more financially literate and take control of their financial futures.  I am a firm believer that with all the negative news and issues surrounding Black America that the one way African Americans can change their situation is to become more financially savvy and empowered.

We hear the statistics all the time about the spending power of African Americans and how our dollars constantly leave the black community and don’t go towards uplifting one another.   How is it possible that the Black community has billions and billions of spending power yet it all seems to go towards sports, entertainment and clothes.  Why is that perception (or reality) so prevalent in our culture?  My answer is it comes down to knowledge and education.  If you do not know what to do with your money then you just spend it.  You don’t think about the future.  You don’t think about your family.  You don’t think about generation building.  You just think about the here and now.  It a self fulfilling prophecy that is a perpetual cycle in the Black community and in Black families.

I hope to share my opinions and view points on these and other issues.  However the main focus will be on personal finance education and dispelling some myths and truths surrounding money.  My eventual goal is to have a new financially educated African American community that understands money and the power it holds for our future.

Hope you enjoy…