Dramatic title I know, but once you understand this concept your wealth can take a dramatic shift moving forward – so it is actually justified. For explanation purposes I’ll assume this is the case of an experienced/savvy real estate investor, even if that isn’t you today the premise shouldn’t be lost or overlooked all the same.
What is dead equity you ask?
It’s really simple, think of it as money/assets you have that aren’t producing income or actively working on your behalf daily. If dead equity was a dog in your living room for example – that dog wouldn’t be fetching or bringing any joy to your life. You might take some comfort in knowing it’s there, but that still isn’t really a useful thing when it comes down to it.
To be clear, that is my definition of dead equity – not the dictionaries. But as it pertains to the personal finance journey this is all you need to know at first.
Let’s say you have a home that is paid off, and that homes value is $300,000. Conventional wisdom would say you’ve done a great job with this, and if safety is your main concern versus wealth building – then you certainly have accomplished that goal. But remember the time value of money? This one works against you in this case.
But…. but… no mortgage is everybody’s goal right?
Wrong. Maximal wealth/cash flow/freedom is the goal of many people, and those 300,000 soldiers are just sitting and not working on your behalf.
What could they do for you? Let’s see. Assume you have a paid for home, and do a cash out refinance of 80% LTV. No you’ve unlocked roughly 240,000 of those soldiers to start working today. Yes, you’ve created a new monthly expense in a mortgage, but front loading makes for a much more impressive snowball long term. How much so? Let’s see the actual math below and let you be the judge.
If you invested $240,000 in an S&P 500 index fund today, and never added anything for the life of that mortgage – your ending balance would be….. $2,415,037.65 assuming an average 8% return. Not bad huh?
Let’s say you go the conservative route, start at zero, keep the home paid for and invest the monthly mortgage payment. A $240,000 loan at 4% interest makes for a nice low monthly payment of $1,146 (P&I, taxes and insurance you’ll be paying either way). So how much do we end up with if that payment is invested every month for 30 years? $1,682,510.44
Neither one sounds terrible, but imagine how much greater the difference is at 40 years? This is also considering you go the easy route and just index it, a savvy real estate investor can likely leverage that money for returns in the 12-18% range via cash flowing rental properties and the math just get’s crazy from there. If you can do the same thing and average a 15% return, in 30 years you’ll have $15,890,825.27! That changes your family tree for many, many generations. I don’t need to tell you what the math looks like at 40 years, but that is true wealth.
If you are a biggerpockets.com follower then you’ve likely read about the BRRR method, using that the leveraged returns of a larger starting sum can be astronomical. Yes, it will take plenty of work to make this happen, but I’ll assume if you are savvy enough to retire an existing mortgage early or save a lump sum of cash then a lazy person isn’t likely here reading this.
In summary, sometimes it pays a great deal to just pay attention to your overall financial situation and optimize in these areas. Even if you don’t have a mortgage free asset, there could still be plenty of dead equity there or elsewhere to work with.
Let’s do the math
Calculate your mortgage or work with the compound interest to see what it can do to expedite your wealth building.