There was a recent article in The Atlantic entitled “The Secret Shame of Middle-Class Americans.” The basic premise of the article is that most middle-class Americans would have trouble even paying for a small $400 emergency. Now a $400 emergency is nothing to sneeze at, but it is fairly common. I mean you need new tires for your car, other car repairs, a new water heater, etc. $400 is actually probably a low number for a number of emergencies and it should be disturbing to a lot of us that Americans can’t even put aside that small amount of money.
We can talk about the reasons for this lack of savings, but I don’t want to get into the blame game with those reasons. I talked earlier this week about the “four walls” emergency fund that at its most basic people should attempt to obtain. But that is still difficult for a lot of people. So the question is how can we make people save? And yes I say make because I do think it isn’t a choice in today’s economy. One of the ways that we can do so is by thinking about our home as a form of forced savings.
Mortgage Payments As Forced Savings
About 63% of Americans own homes and there is greater evidence that millennials are starting to buy homes in great numbers. That is a good thing because I think home ownership is generally a positive outcome for most. Considering one pays down their mortgage we should not only think of the mortgage as a form of debt, but our home purchase as form of savings that we engage in every month. In other words, we need to reframe our thinking a bit on paying off our home.
On average homes go up in value. It is really the only major asset that we will own that will do so. Your car won’t, your diamond engagement ring won’t, and unless you own lots of gold that most likely won’t go up in value either (besides gold is a HORRIBLE investment). Typically that value will go up about 3-4% per year depending on the area you live in or at least that has been the historical averages. When you pay your mortgage each month you are paying down taxes and principle. The amount of that pay down depends on the size of the mortgage and the terms, but this year for example our home should go up in value about 3% and we will have paid down about $10,000 in principle. In other words, we will get an increase of about $15-$20,000 in net worth because of those mortgage payments. So by paying your mortgage you are saving money because you are increasing your net worth. Your investment is growing and the debt that you owe is going down. Thus, you have built-in savings.
Accessing These Home Savings
Now here is the tricky part. Even though you are saving it is often difficult to access the equity in your home for small things. In fact I am against it most of the time. I think some of the trouble we got into during the 2000s was that people used their homes like ATM machines. They tapped the equity and bought cars, boats, vacations, and/or rolled other debt into their mortgage.
If you decide to tap your home equity for a vacation I think that is just plain stupid. If you can’t pay for a vacation then don’t take one. However, if you encounter a MAJOR emergency (not $400) then having your home equity as a potential emergency fund can be an option.
Now I still think everyone should have LIQUID cash of some kind to tap (e.g. $1000 emergency fund) but if you have a larger emergency and need to pay for things most people can obtain a HELOC (Home equity line of credit). In essence, a HELOC is a line of credit that you can use to pay for certain expenses. It is NOT a piggy bank. You can’t get an ATM card for it and you have to pay that money back. But the interest on that HELOC is often fairly low.
Additionally, HELOCs are typically only for a certain time (e.g. 5 or 10 years) and always are Adjustable Rate Mortgages so if interest rates go up your HELOC rate will go up as well.
The reason I like a HELOC over a home equity loan for potential savings is that with the loan I am afraid of people blowing it. With a HELOC and it being a line of credit people don’t necessarily get the sum of money all at once.
Again, I don’t advocate you use a HELOC or home equity loan unless it is an absolute emergency. HELOCs are not for cars, vacations, or other debts. They are kind of last line of defense for those who really need it, but HELOCs are only available if you have a certain amount of equity in your home, which comes from the savings that grow by paying down your mortgage and increasing the value of your home.
The Bottom Line: I will continue to write about the need to save for retirement and emergencies. It is something that the ROB household needs to do a better job of as well. I am tired of living paycheck to paycheck like others. I want FU money. But we also need to focus on encouraging people to save rather than always telling them they are behind. One of the ways to do that is to reframe the way we think about other items and thinking about your mortgage as a form of forced savings is one of those tricks.