Special offer

Equity Harvesting; Ask Yourself, Who Does it Benefit? The Cost of Equity Harvesting vs. The Cost of the MMA

By
Mortgage and Lending with Logical Choice Lending, Inc.

The hot strategy in the mortgage industry as of late is to push the concept of Equity Harvesting.  This is a strategy where homeowners are advised to refinance there homes every five years or so and take cash out the equity position in the property to invest elsewhere.  The idea is that by borrowing at one rate and investing at another will create a personal arbitrage which will allow people to accelerate the creation of wealth.  I have posted another blog which outlines 6 potential pitfalls to this strategy that are rarely if ever mentioned by its advocates and it can be read by clicking the link below.

 

Money Merge Account vs. Equity Harvesting - The Truth

What I am going to address in this blog is how the parties who are advocating this strategy are compensated.  I am addressing this point because I am an advocate of the Money Merge Account and it seems that those who advocate the Equity Harvesting Strategy and create posts in opposition of the MMA continuously point to the cost of the MMA Software ($3,500.00) as being objectionable.  None of them can say that the strategy doesn't work, because it does, so they attack the price tag.  So let's compare the costs of Equity Harvesting vs. The Cost of the MMA.

Please note that I do not like to use assumptions but I am using them in this example because they are the same or relatively similar to the assumptions used by many of the proponents of Equity Harvesting.  I will not be delving into the ASSUMPTIVE rates of return on the proposed investment side of the strategy as I am only comparing costs.

For the sake of argument we are going to say that our fictitious family owns a home worth $200,000.00 on which they have a $100,000.00 balance.  We will also use the popular assumption that homes appreciate at 4% and this fictitious family is planning on implementing an Equity Harvesting Strategy which will entail a refinance every five years, starting with the first refinance take place immediately.  We will also assume an interest only loan is used and there by the loan balance will not be decreased as is so frequently the advice of those advocating Equity Harvesting.  I am going to also assume that the mortgage professional will be earning a total commission of 1% of the loan amount.  Please note many mortgage professionals will be compensated much more but I am using the lowest end of the cost spectrum to illustrate this point.  Simply put, it is highly unlikely that these transactions will cost less then what I am outlining and more likely then not, cost much more.  Also note that I am not including additional cost that are incurred through refinancing such as establishment of new escrow accounts or increased insurance premiums.  I will also assume (here I go again) that the money will be invested with a fee based Investment Advisor who charges 1% per year of the assets under management.  I will also use closing costs in Florida as that is where I do business.

Refinance Year 1

Home Value                                $200,000.00

New Loan Amount                      $160,000.00

Pay off                                         $100,000.00

Tax & Title Fees                               3,200.00

Mortgage Commission                     1,600.00

Loan Cost to Borrower                     4,800.00

Capital to Invest                              55,200.00

 

Refinance Year 5

Home Value                                $252,688.00

New Loan Amount                      $202,150.40

Pay off                                         $160,000.00

Tax & Title Fees                               4,040.00

Mortgage Commission                     2,021.50

Loan Cost to Borrower                     6,061.50

Capital to Invest                              36,088.90

 

Refinance Year 10

Home Value                                $307,433.00

New Loan Amount                      $245,946.40

Pay off                                         $202,150.40

Tax & Title Fees                               4,919.00

Mortgage Commission                     2,459.46

Loan Cost to Borrower                     7,278.46

Capital to Invest                              36,517.54

 

Summary of Mortgage Commission

Year 1    $1,600.00

Year 5    $2,021.50

Year 10  $2,459.46

Total      $6,080.96

 

10 Year Summary of Loan Cost (Including Mortgage Commissions)

Year 1    $4,800.00

Year 5    $6,061.50

Year 10  $7,278.46

Total      $18,079.96

 

Now if the investment advisor earns 1% of the assets under management per year, and does not lose or make any money, here is the commission break down.

 

Year 1    $552.00

Year 2    $552.00

Year 3    $552.00

Year 4    $552.00

Year 5    $913.00

Year 6    $913.00

Year 7    $913.00

Year 8    $913.00

Year 9    $913.00

Year 10  $1,276.48

Total Investment Commissions over the first 10 Years = $8,049.48

 

10 Year Loan Cost $18,079.96 + 10 Year Investment Commissions $8,049.48 =

Total Costs after 10 Years of Equity Harvesting $26,129.44

 

Wow!!! And the advocates of Equity Harvesting have the nerve to bash the measly, one time licensing fee of $3,500 for the MMA Software.

10 Year Equity Harvesting Cost    $26,129.44

MMA Software License                  3,500.00

Savings                                   $22,629.44

Melvin Green
1st choice family - Richmond, VA
I like what your doing keep it up I'm with uff to and I thank you for putting that out there. How are things down where you are I'm in VA let me know email me truemodesty@aol.com
Jun 26, 2007 02:48 AM
David A. Podgursky PA
THE PODGURSKY GROUP @ Re/Max Direct - Boynton Beach, FL
THE PODGURSKY GROUP - Make the Right Move!

this only works if you have a client in the financial position to not have a mortgage

plus - having an asset fully paid off means that a lot of money that they could need in the future is illiquid.

 So... why not deduct the cost of a refinance during retirement with no ability to repay due to income shortage from your savings to show the real cost of free and clear ownership?

I also don't get the 1% advisor fees or the $3400 MMA costs as they seem to be paying into something that you could do without either.

also - your assumption of mortgage commission only assumes that a broker would charge a fee for the service which isn't always the case. 

I think the biggest issue of all these arguments is the ASSUMING... you ASSUME that the MMA is the holy grail when most people do not fit the program in the least.

That is why it remains a niche product.

Jun 26, 2007 02:56 AM
Jason Leone
Logical Choice Lending, Inc. - Fort Lauderdale, FL

David, 

 ‘This only works if you have a client who's goal is to payoff the mortgage and has their finances ordered in such a way as that they have discretionary income' is a more appropriate observation.

Having "an asset" (the home) paid off also means no mortgage payment, thus hence, less need for liquidity from a cash flow standpoint and as the MMA employs the use of a HELOC the equity can be made liquid through its use.

As far as the cost of refinancing during retirement is concerned; I do not advocate the use of an MMA instead of contributing to qualified retirement plans.  Contribution to 401(k), 403(b), IRA's and other retirement and financial planning instruments are definitely priority.  In most instances, I do however disagree with borrowing money to fund these vehicles for all the reasons I mentioned in my previous blog: Money Merge Account vs. Equity Harvesting - The Truth.  In addition the use of a Reverse Mortgage can be employed by retirees to access the equity in there home if necessary.  Reverse Mortgages have caps on their closing costs and do not require the borrower to make mortgage payments.  They also have no income or credit score requirements, they are approved based on the age of the borrower and the equity position they have in their home.

Moving right along, let's address the 1% advisor fee.  This is the fee that most Registered Investment Advisors (Series 65) charge.  It is typically 1% of the assets under management.  This is the least expensive option available in terms of having your money professionally managed.  There are other options, but I was using the lowest cost options I am aware of for implementing the Equity Harvesting Strategy.  You sir, have an MBA and may very well be able to manage your own investment portfolio, however I can not ethically advise the clients of mine who have professions such as UPS Driver, Auto Mechanic, School Bus Driver, Contract Carpenter, Wall Paper Installer and the like to take their money out of their equity and invest in instruments that carry capital risk without the advice of a professional and last time I checked these professionals typically needed to be compensated.

Again we return to the cost of the MMA Software.  The MMA Software is a tool and the cost of this tool is $3,500.00.  It is my opinion that this tool best accomplishes the job it was designed to do.  If another tool becomes available that accomplishes the job better and for less money, I can assure you, I will utilize and recommend that tool instead.  If I needed to chop down a tree I could use a $33.00 hatchet or I could use a $100.00 chain saw.  The choice is mine.  I personally prefer the efficiency of the chain saw.  I don't need a $3,000.00 GPS in my car; it does however save me significant time in traveling from appointment to appointment.  My point being is that if something gives you greater use value then what you pay in cash value, it's worth the expense.  You may not need the software personally because of your education and knowledge of finance, but do you believe that everyone else is as knowledgeable as you are?  If they were then what purpose would you serve?  The same holds true for the software.  If you have the knowledge to implement the strategy without its use, fantastic, save the $3,500.00, by the same token, if you don't then, its money well spent.

As far as the mortgage broker not charging a fee is concerned, you and I both know that the broker is going to get a fee.  It will be on the front, on the back or both.  If you figure out a way to give out free mortgages and still make money as a mortgage broker, let me know what it is and I will be the first to sign up.  If the fee is on the front then I have already addressed this.  If it is on the back then the interest rate that the borrower pays will be higher and it will be even more difficult to obtain a rate of return higher then that of the rate of interest being paid further eroding the potential profit of the arbitrage.

As far as the ASSUMING goes, I addressed it in my preceding blog and I know you read it because you commented on it.  I don't "ASSUME" the MMA is the Holy Grail, I sincerely believe that it is a more advantageous solution for my client, base taking into account current market condition, then equity harvesting.  In addition, in presenting both options objectively, to my clients that qualify, I find much greater receptivity to the MMA strategy.

In closing I will state that upon analyzing my database, I found that 60% of my clients have credit scores over 700 and currently have a line of credit on their home.  If 60% is a niche, it's one a pretty wide one.

Jun 26, 2007 07:11 AM