This was born out of brainstorming around the strange current financial conditions and how we might maximize today's situation.
30-year mortgage rates are now about 3%.
The expected return for asset classes, such as stocks and other risk assets, is significantly higher, perhaps 5%+.
But obviously, they come with a lot of risks, so this isn't for everyone. Heck, it might not be right for anyone. This is just a brainstorming exercise, and I love brainstorming with clients. It's one of my favorite things to do.
For individuals with the means to take the risk, it might make sense, from a long-term perspective, to leverage the asset and invest it in a low-cost portfolio.
Let's do some rough math to see how this might work.
- Assume for round numbers we did a cash-out 30-year refinance of $100,000 at 3% net of all fees.
- The monthly payment which could come from the investment account would be about $422 a month or $5,059 a year, about 5% of the starting value.
- The extra 2% is the principal paydown, aka you paying yourself back with your own money.
- If we wanted a 5-year safety cushion against losses, we could allocate five years of payments or $25,000 to cash, bonds, and alternatives.
- The rest could be invested in a well-diversified stock portfolio, which would probably yield about 2% or more a year just from interest and dividends.
- This could be used to help cover 2/3rds of the 3% interest cost. So now our break-even appreciation needed to cover the interest is just 1% annually!
- If the stock markets price return (excluding dividends) exceeds 1% a year over the 30-year period you win.
Ben Carlson is a great financial writer, and I took the following from one of his articles "Deconstructing 30 Year Stock Market Returns”.
I get it, these days, people are scared and skeptical.
But look at these periods that were also pretty scary!
The Great Depression
a stock market crash of more than 80%
World War II
The Korean War
and four recessions.
The Civil Rights Movement
the Vietnam War
a president was assassinated and another forced to resign
an oil price shock from the OPEC embargo
double digit inflation and interest rates
and six recessions.
Black Monday in 1987
the Savings & Loan crisis
wars in Iraq and Afghanistan
and three recessions.
Now, there all sorts of warnings and caveats here. Never enter into anything like this lightly. There might be prohibitions about investing mortgaged money, tax issues, fees, behavioral issues, moving considerations, etc. Check with your tax advisor, financial advisors, and possibly attorneys.
So, what would be the benefit?
For this example, we’ll assume a 5% annual return, or half of what the markets have done in the previous 30-year periods.
This strategy could yield a simplified net 2% a year.
$100,000 would likely be $180,000 or more, or about $2,700 a year on average.
Maybe not anything to write home about, but if we did 3% over the 3% mortgage rate, that would be about 242k.
or 6% over, a 9% average annual return, which is getting close to the historical averages—$574k.
Then perhaps don’t do $100,000, maybe you can do $500,000?
Then we are looking at that $500,000 becoming:
3% over the mortgage rate = $900,000
4% over the mortgage rate = $1,625,000
5% over the mortgage rate = $2,160,000
6% over the mortgage rate = $2,870,000
7% over the mortgage rate = $3,800,000
Finally, let’s look at the case for those that doubt you would stay in the home that long. Assuming it was paid off before the mortgage cash out, you could simply pay off the mortgage when you sell the home and maintain what was left of the investment portfolio.
The mind wanders so much around things like this. There are lots of risks here, obviously, but for someone perhaps with $5m+ and a desire to maximize their family’s long-term wealth, this is a possible opportunity.
Thanks for taking a look!