Receive an inheritance: Should you pay off your mortgage?
I am currently in Seattle with my family visiting my father. As we drive around, it’s hard to miss the radio advertisements urging people to register for various “free” seminars to learn how to make lots of money in real estate. For the last few years, Seattle has been home to the hottest real-estate market in the US.
While I have heard about a few families in the Orthodox community who have decided to bank some money by selling their home and moving to much cheaper cities, the majority of people I have spoken to think prices will continue going up. I had a meeting with someone who has a rather complicated situation with family real estate holdings in the Seattle area. For a while now I have encouraged him to liquidate all the holdings and distribute the cash proceeds among the various owners in order to make future inheritances go much more smoothly.
To say that I was rebuffed is an understatement. I was told off on how foolish it would be to sell now because prices are sure to continue to rise. In many respects, it sounds remarkably similar to the current real-estate market in Israel. Both places have limited supply, huge demand, owners who think real estate can never go down and governments who have no idea how to deal with the problem.
This affinity with real estate isn’t a bad thing at all. After all, I have written here more than once that I am a fan of investment. The more invested the better. Sure, I think that investors need to allocate their resources among various asset classes, including stocks, bonds and real estate. Better to invest than to drop all your hard-earned money at a duty-free shop buying unusual sizes of chocolate!
Before I traveled I had a meeting with a lady who had just received a very nice inheritance. As we were speaking she asked if I thought it would be wise to use almost all the money to pay down the mortgage, or use it to buy another apartment. I explained to her that this is a very common question that I am asked. • Grow Wealth After reviewing her financial situation, it turned out that aside from this new inheritance, she had no real other assets except for the apartment she is living in, which has a sizable mortgage. Readers of this column know that I hate debt. You will probably think that I advised her to take all the money and throw it at the mortgage to get rid of it. Well, my actual advice was a bit different. It’s true that I hate debt; It’s also true that I love having liquidity. • What is liquidity? Liquidity is the ability to quickly convert an investment into cash without losing any of the principal that you’ve invested. For example, a savings account is highly liquid. In contrast, real estate is considered to have low liquidity because of the time it takes to sell the property. If you need to sell quickly, like a fire sale, you will end up paying the piper as the price of your property will drop.
I suggested that since she has no other investments other than her home, she should take a 25%-30% chunk of the money and get it invested in a portfolio of stocks and bonds and use the rest to pre-pay down a good portion of the mortgage. Why not just pay off the whole thing? Because too often, I see couples who ended up putting every last cent they have into their home. While they may have very respectable net worth, 95% of their money is tied up in a property. How will they pay for a wedding, or some other large expense?
You can’t take a saw and cut off a room and say, “Take a bedroom, it’s worth $50,000.” It just doesn’t work that way.
In general, I recommend trying to save 10%-15% of your income in financial assets and anything above that should go to pay off your mortgage. As I have written, any savings is better than no savings. But it’s better to be smart about your finances. By saving money in parallel tracks, real-estate and liquidfinancial investments, you will be able pay for future expenses without having to sell off property and end up growing your wealth in a more efficient fashion.
The writer is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGrawHill), and is a licensed financial professional both in the United States and Israel. For more information, call (02) 624-0995, visit www.aaronkatsman.com or email aaron@lighthousecapital.co.il.