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
Comments(3)