AAR60 - Money Debates 2 - Early Mortgage Payoff? Emergency Fund vs. HELOC

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2:43Good day, everyone, and welcome back to At Any Rate. My name is Evan Ray, and we are here to help you make sustainable financial changes without breaking a sweat. And after the last episode, I did have to beg and plead for him to come back, but he has graciously accepted. Please welcome back Andrew Sather. I got new boxing gloves, so I'm ready for a fair fight. And there's no metal plates hidden inside the paddock, right? This is a fair fight. I plead the fifth. Okay. All right. Well, I might not be able to plead the fifth after this then, depending on how this goes. So if any of the listeners did not listen to the previous episode, I would recommend going back.

3:23Don't have to, of course, but I'd recommend it. That was episode 58. And this is going to be the episode two to that of Money Debate. So we're going to be going over some basically financial concepts that have two sides to the argument. We're going to present, each of us are going to present each side of the argument. and then we're going to divulge which side of it we actually agree with. And as happened last time, sometimes our opinions will change partway through based on the other person's arguments. So that's kind of the format of it. Anything else left to explain you think, Andrew? Oh, let's do it.

3:55Beautiful. All right, you go ahead and start it off then. The first topic is going to be home savings using an emergency fund versus using a heat lock. Right. So with the assumption that you're having an emergency, what do you do with it? I kind of came up with disadvantages to the HELOC rather than advantages to having an emergency fund. So I feel like I'm just like attacking right away before you've even had a chance to defend yourself. All over it is the title to the topic and that's it. Right. A little bit of a sucker punch, But HELOC, Home Equity Line of Credit is what it stands for. Some disadvantages to using that for an emergency.

4:41The obvious one is interest rates change. And so if interest rates go higher, you're at risk of having now a higher payment, having more debt. Because the HELOCs tend to have this floating interest rate. So that is a big risk. And as we are seeing in the financial markets lately with a new chair in the Fed who's very hawkish, which means he's more conservative with the setting of the interest rates. That's at least the way people are perceiving him. And so this whole higher interest rate could be for longer than we all thought. But HELOC also gives you more risk of potentially losing your home if that loan goes the opposite way.

5:32And I think we all don't want that. And there's also extra fees, closing costs, appraisals, and things like that. And also even annual maintenance fees or inactivity fees. So basically at this point, there's like zero good reasons to have a HELOC. but I would just give you the floor anyway, just out of respect here. That is so kind of you. You're clearly a very respectful debater, so I think that's very clear to everybody at this point. So yeah, to just kind of explain real quick what a home equity line of credit is, it's kind of fairly self-explanatory by the name. You're taking out a line of credit or a loan against the home equity that you currently have.

6:14So say you've been paying off your home for a few years and you've got, you know,$50 ,000 worth of home equity that you've built up. So you own$50 ,000 worth of the home. Then that means that you could take out a line of credit, maybe not for the full 50 ,000, but for some amount and take away from that equity temporarily. And then you have to pay it back at a set interest rate. And like Andrew mentioned, that is a very good point that I don't think is emphasized enough is that there's the fees alongside that. That is definitely a downside. All the costs that go along with it, like you mentioned appraisal, because they have to figure out how much the home is worth to finalize exactly how much equity you've built up.

6:50So it's a bit of a process to go through. I would kind of immediately hamper myself by saying as a general emergency fund, a HELOC is not a good idea. Like if you're, you know, we talked last time about like somebody breaks your window or something. You don't want to have to take out a HELOC to fix a broken window because it's going to be, the fees would probably add up to as much as the window replacement. however a lot of emphasis I think towards HELOCs for things like home improvement or things like having to get the roof replaced or if there was an expansion on the back of the home or severe damage somewhere these amounts of money can add up really really quickly and turn into tens of thousands of dollars and I think that we put a little bit too much of a requirement and an emphasis on people having tens and tens of thousands of dollars saved for their home because like that sounds great you know the math works out go ahead and do it but number one that money is never going to build as quickly as it could elsewhere that's kind of the first argument to it but also for a lot of people it's just not realistic to save up tens and tens of thousands of dollars in cash and have that sit somewhere that's just not feasible and so if you say that that's not feasible then the next argument becomes okay well when they have to get the roof replaced how the heck are they going to pay for it and i think that a heloc is one of the best ways to access that money because you're essentially taking a loan out against yourself to some degree again there's you know other parties involved in everything of course but to some degree you're just taking a loan against yourself you're paying yourself back and everything um plus interest to the the party that's that's helping you access it um but i think that that's just the most realistic way for a lot of people to be able to get things done on their homes that need to be done or maybe they want it to get done maybe it's a big home improvement project that they want to do that again they haven't saved up tens of thousands elsewhere well you've saved up tens of thousands in home equity so go ahead and access that to help you out um so yeah those are the kind of the pros that i see to it um but again for a general emergency fund or general savings i would i would say absolutely not to a heloc uh that's very practical of you like i feel like i came in here bashing people over the head with math and that is a very big reality like how many of us have 30 grand or i'm sure the costs now are astronomical for replacing the roof i don't oh my gosh yeah i yeah i remember exactly but i i do have co-workers that have paid like 35 000 to get a roof replaced and that's right yeah that's not realistic to have it in cash and i I guess, yeah, it's not like going to a car dealership where they have a financing arm.

9:37I don't know of any roofing. Maybe it's a thing. You never know. But it doesn't seem like one of those things that's common of being able to get specific financing for a specific job like that. Yeah, for sure. And as with everything else, HELOC rates will fluctuate significantly, just like everywhere else. But in general, HELOC rates can be pretty decent. In general, they're 6.5 % to 7%, which isn't great, but it's not horrible. But at some local banks and credit unions and stuff, you can get that down. I've seen it to like 4 % to 5%. And if you can get it closer to that kind of a rate, then that's just, to kind of put it frankly, not that bad of a loan to take out.

10:18You know what I mean? Especially if we talk about, okay, well, you've built up this equity. Now you have savings elsewhere. that savings elsewhere could be in the market or in bonds or somewhere else that it could grow at a significantly higher rate, closer to 10 % than prioritizing paying off this HELOC or putting it in a savings account that's going to earn 4 % in a high-yield savings account or something like that. I just think you could grow it much more quickly elsewhere and then access the equity when you really, really need that amount of money. so that was actually going to be my question to you but basically you've kind of answered it rather access a HELOC than withdraw early from retirement for example yeah that's a very good question i would i would strongly lean that way for sure i think um again with a HELOC you're only taking a loan from yourself temporarily and it's it's at least planned to be paid off um in a relatively quick fashion whereas pulling from retirement that's the way i kind of think about pulling from retirement is that it's money that you can't get back not because you can't you know make that money back or pay it off the same way as you could heloc but your contributions to retirement accounts can't just be redone like say you were at an employer and you were able to contribute you know a certain amount while you were there you can never just make up for that contribution there are limits each year and if you were maybe getting close to the limit you can't catch yourself back up.

11:47There are some catch-up rules later in life, but for most of your life, you can't catch up. And then same with the Roth IRA, there are even lower limits to that, about 7 ,000, 7 ,500 now. And if you pull out 10 grand or something, you can't just say, oh, okay, I'm done with that money. Let me put the 10 grand back in. You can't do that. You still have to wait and keep with the current rate. So I think of them as accessible when you really need them life or death but not accessible um to just pull from to pay for something for the house yeah so i feel like i'm losing this fight so i'm going to actually redirect and kind of like pivot over this way i would say if you're looking at because i've heard this argument and it used to be popular during um the 2000s but basically this idea that i'm going to pull out the heloc to redo my kitchen because I'm tired of the color and that's going to increase the value.

12:43And so it's like a wash. I'm borrowing against the equity, but I'm raising the equity because I'm doing a renovation and everything's all good and dandy. And I would say that's an absolutely terrible way to use a HELOC for all the reasons that are the disadvantages. And also for the reasons that even though real estate does across the United States, historically going back to even the forties and maybe even before that, I had specific numbers that I've looked at before, but that's somewhere around like 5 % a year. Obviously some areas of the country are more, some are less, but that's kind of like a number you can anchor to and reference when it comes to how much is my equity going to increase over the very long term?

13:31But like we all seen, that's not a straight line up and to the right, even if there are periods of time where it is that way. So you can come up against situations and it's not going to be as extreme as a margin call, but we have seen what happens when asset prices fall. I don't know if you followed what's happened in South Korea lately. I haven't, no. really sad like something like a quarter of um i don't know if it was working people there's like a ton of people who are really into the stock market right now in south korea with all the memory prices going through the roof and that benefiting some of those stocks that they have their own like bubble over there and a bunch of people like a significant amount of people got wiped out because that bubble popped and they were all leveraged and then you get margin called which means you have to put up more collateral.

14:24And if you don't, you get automatically liquidated. So that could, in theory, happen to your house if your equity was worth, I'm just going to throw out completely theoretical numbers. If your equity was worth$400 ,000, now it's$200 ,000 because home prices have crashed. Now, in order to get back to that percentage of how much you're borrowing, loan to value, you got to put up more capital and so yeah it can it can definitely go the wrong way um and we need to be careful about that yeah yeah that's a very good point um and kind of to that i'm not going to go quoting around exact percentages because i'm not an expert on helix or anything there are a lot of people that are experts in the real estate business and that is that is not my forte um but i would say that try to follow some of whatever those rules are that exist because yeah you would want to see a HELOC as I've already saved up a ton of equity.

15:21I want to take a little bit of it to help me with whatever this is or pay for whatever I need. You don't want to see it as let's pull a big chunk of, of, you know, equity that's left. Um, because like Andrew said, if, if the home price falls significantly for some reason, or, or you could even consider, well, you have some other actual emergency, maybe say you were, you know, pulled out money to, to pay for repainting the kitchen, like Andrew said, and then, then you have to actually replace the roof for some reason, now you've kind of, you've stretched yourself too thin where now you can't afford the thing that you really need to afford.

15:52Or if the home price falls, then now you might start breaking, breaking the rules, so to speak, or going past the limits and you're going to have to pay even more just, just to cover it. So all of this should definitely be done with, with a margin of safety, a significant margin of safety to give yourself room to handle whatever happens. Now, now we're in the middle of the ring, like shaking hands. Cause it's like an agreement here. If everybody's smiling, I appreciate that. Well, all right. We reached a good agreement on the end of that one. So let's see if the same thing happens with the next one.

16:26Next one is going to be paying off your mortgage early versus not. I'll go ahead and start this off with the not side of things, why you may not want to pay off your mortgage early. I would say that this one is going to be very circumstantial. It's going to depend on your financial situation. It's going to depend on what your interest rate is on your mortgage. It's going to depend on a lot of things. But I would say that in general, mortgage rates are not a very high rate. And I think that a lot of people focus on paying it off. Something I see a lot on social media. Somebody will go to their mortgage lender's website and they'll have a calculator on there.

17:05And it says, oh, if you pay$100 more a month, you could save freaking$12 ,000 on your mortgage or something. Crazy, crazy numbers. And that's fantastic. And I like that it emphasizes the effect of relatively small changes now having massive changes in the future. The thing that I don't like about it, although I don't really blame the lenders for framing it this way, is that they're not comparing that to what if you did something else with that$100. The assumption is kind of either you save it in cash and it kind of wastes away or you put it here and suddenly you've saved a crap ton of money. the other option is that you put that money elsewhere instead and you realize when you put that money elsewhere that that number that you're seeing that 12 000 could actually be 35 000 you know just different time periods or whatever because that money could actually grow at a even higher rate elsewhere um i know us for example i mean we got a good rate i will i will say but um our rate our mortgage interest rate is four percent so we got a good solid rate so that's even more true for us but even for a lot of people out there that got five and a half six six and a half seven percent interest rates if you compare that to something like the stock market that on average will grow closer to ten percent that that is still a wash where you would rather just put that money elsewhere and grow it significantly more and i think that that the biggest issue with people or the biggest thing that leads people to assume that paying off the mortgage early is such a better deal for them is the accessibility of these calculators.

18:37They immediately see that number and think this is the best place to do it. But if there was a compound interest calculator sitting right next to it, where they could, you know, choose a dropdown and say, oh, did I pay off my mortgage or at this interest rate, or did I put it in the stock market, or did I put it in real estate elsewhere, you know, whatever it is, then suddenly that would look very, very different. And plus one more thing that I want to kind of say on it is this kind of goes back to the HELOCs that we were discussing before, if you decide to pay off the mortgage early, though that money is now building up to some degree, at least in equity in your home, and that's great.

19:09There's nothing wrong with that. The issue is that, like we mentioned, home equity is not the most accessible thing in the world, and it's definitely not something that you want to or should use for just anything that you might need. But depending on where you put that money elsewhere, let's say again, instead of paying off your mortgage early, you put it in the stock market or something, say it wasn't a retirement account just a taxable investment account that you could pull from basically whenever you want and just pay the taxes on the gains that is much more accessible to you and if you say in five years you needed to to wanted to repaint your kitchen like we were mentioning the money that's in that taxable investment account will have at least theoretically based on average averages have grown even further than it would have earned you in your mortgage and it would be much more accessible for far fewer fees and taxes and you know also a lot less of a headache to go through, whatever it is, just a ton of upsides to make that a lot more accessible to you to pay for whatever you need to.

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22:22Join at functionhealth.com slash beginners and use gift code beginners25. What's the best way to get started in the market? Download my ebook for free at stockmarketpdf.com. Well, we're going to come in with all vibes, okay? That is the magic carpet I'm writing on. So you pay off your mortgage early. That is a peace of mind that just feels great. I've heard people say like this is like on a podcast so it's one of these personal finance gurus but like the grass under your feet feels different when the house is paid off my grass already feels pretty good so I think that's debatable but I think the general idea of except where my dog pees on that grass doesn't that'll never be paid off

23:16so that's definitely a benefit is like, Hey, I don't have this hanging over my head anymore. And so what does that do? It frees up your budget. It frees up your monthly expenses. So you could take like a sabbatical or you could, you know, see yourself a lot closer to your retirement, maybe even do an early retirement because your expenses were four grand a month. Now they're two grand a month. And it also just makes life that much easier. You can save so much more when your expense, that big expense is gone. You also save money on the interest rate, right? Like even though, yes, it's not that high of an interest rate, for some people it might be.

24:00And that does compound as well. So if you are somebody who does not like the scariness, the volatility, the rollercoaster effect of the stock market, at least when you're paying off a mortgage early, that's a guaranteed return. You know that my interest rate's six and a half. I know I'm putting this money in and I'm getting six and a half. And it also has a compounding effect because as you pay off more and more of the loan, your interest expense goes lower and lower. So not the monthly that you're paying, but the amount of money that's paying off your loan. It's kind of like a, I can't visualize the curve, so we'll just forget what I'm saying.

24:48But basically the beginning of the loan, a lot of your payment's going to interest near the end of your mortgage. A lot of that's going down to the principal and is going just straight equity. And so you're really making a lot of progress when you get on that other half of the interest curve and i rest my case yeah i i would say that this one base is based a lot on your personality if you if you have the personality of um and there's nothing wrong with with either side of this if debt really scares the crap out of you it's just a lot of people debt is a big big fear for them in life in general if that scares you a lot if trying to manage it or seeing those numbers feels very overwhelming for you and maybe you don't want to go through the process of doing the math to prove that like hey i'll be okay you know i'm making the best decision but still seeing the the situation that you're left in still scares you completely understandable that's okay i would say that probably paying off the mortgage early is a better way to go like andrew was saying the peace of mind is amazing and seeing that calculator on your mortgage lender's website is going to feel fantastic.

26:00You're going to see that, oh, I'm putting 150 more towards this every month. That's going to save me so many, multiple years and tens of thousands of dollars of interest. That's fantastic. Nothing wrong with that. Go ahead. I would say that if you're willing to do the math on things and run through what the best scenario for yourself actually is and run just simple compound interest calculators. Again, there's a ton of websites to do this kind of stuff. You don't have to build it or look up the math yourself or whatever. Look up compound interest calculator website and plug some numbers in for how much you would put elsewhere in something like the stock market.

26:33Give it a reasonable stock market rate and then add that to your wealth after X number of years and then do the same thing. But instead of having a stock market return rate, put your mortgage interest rate and see how much you would have earned after that many years. and that's when you'll realize that though the lender's website is not lying whatsoever, you can be very confident that putting your money elsewhere is going to grow much, much more quickly and again, be far more accessible for you. All dependent on personalities, but I would say that the actual mathematical argument of it is completely one-sided.

27:12So for you personally, I'd love to know what team you're on. we could talk about team scrambled eggs or team over easy but i also want to over easy for sure over easy for sure i say it depends i mean it depends on what like if you're having a bagel you might put over put over easy on it no that's too messy yeah no it's too corned beef hash though over corned beef hash yeah that's oh man so good so good but but what team are you on for like for you personally paying off mortgage early versus not i am definitely on the side of not um again that is also because of our interest rate we have a a nice low interest rate especially for the current market and so there's just you know a four percent upside basically for us paying the mortgage off early is just not enough of an upside to worry about and again i've done the calculator on the lender's website i saw that and i was like Like, wow, this is in some ways kind of cool because, again, it emphasizes how important decisions can be.

28:13But, again, also kind of pushing people away from putting that money elsewhere without them even realizing that those other options exist. So I instead just pay off the mortgage at the expected rate and then prioritize putting that money into the stock market, into retirement accounts like Roth IRA, 401k, that sort of stuff. And just knowing that the wealth will grow much, much more quickly in those other places. How about you, though? stock market junkie got a tattooed on my chest i think we know where i stand well that one was easy all right third one here we've got lump sum versus dca or dollar cost average um if you were to get a windfall today so windfall meaning you know you you were walking down the street you saw a ten dollar bill you picked up that ten dollar bill you found ten thousand other one dollar bills underneath it, you now have$10 ,010.

29:08What do you do with that$10 ,010? You want to kick it off? After I take a round around my block and see if there's any of that. That's really nice. Good to check. All right. So it's pretty simple. Very easy. Time in the market beats timing the market. And so what that means is over the long term, the stock market goes up more than it goes down. Obviously, that depends on what time period you're looking at. Yes, there are extended periods of time where that doesn't make sense, or that is not true, but for the vast majority over decades and decades and decades, the stock market is usually up more than it's down over a yearly basis.

29:56So because of that, the sooner you put money in, most of the time that money is going up by the end of the year. And so just probabilistically you have a better chance of winning that scenario. And so because the odds are on your side you just put the whole thing in and you got those extra months of compounding that you didn't have by dollar cost averaging. it sounded to me like Andrew has a gambling problem because putting in putting an entire windfall at once though definitely giving giving you more time in the market and if the market just continues upwards after that then that's fantastic but if the market doesn't for the short term continue upwards afterwards then you are going to feel that shock a lot or say you put in that lump so you found that ten thousand ten dollars at you know at the peak of a run in the market, then when it drops, you're going to feel that drop way, way more than you would have without that 10 ,000 being in there.

31:01Or if you've done dollar cost averaging for anybody that doesn't know dollar cost averaging is basically putting in a set amount of money at a set rate into the market. So say you find that$10 ,000 and you say, okay, I'm going to put a thousand dollars a month until the$10 ,000 is gone. That would be dollar cost averaging. And the intent of it is that you just average out your cost basis or the average cost that you paid for a given stock over time. So if Andrew puts in that lump sum, then whatever the price of that stock is at that point, he's all in on that price and it has to go up from that price as quickly as possible for him to start earning money.

31:37If we dollar cost average in, then even if we start dollar cost averaging at a huge peak in the stock market, when it starts dipping, we're going to continue buying that dip and we're just going to bring our costs down lower than it would have been otherwise. and then when it starts going up in the end our average cost we paid would be lower than Andrew's average cost the the good thing I see about DCA is that it's just a nice it's it's a really good safe and easy and controlled way to do things um while I don't think that it's always right and we can kind of uh agree on that a little bit um I think that for a lot of people DCA is just a good, safe, easy way to do things.