Those who followed this bad advice⎯made popular by misguided columnists and the Suze Ormans of the world⎯may feel more secure believing they have made a good decision by putting their spare cash into their homes. But what they have done is locked up their wealth and now, with stagnant or falling home prices, they are condemned to watch helplessly as their net worth is eroded by market forces and inflation.

The idea that paying off your mortgage is a smart move is Depression-era thinking that makes no sense, and didn’t even during the Depression. The math is simple and can be quite painful, as one of my clients recently discovered.

He and his wife fell in love with a piece of property and decided they wanted to sell their present house, which they owned free and clear, and build a new one. The rest of their wealth was invested in the stock market.

I urged him to borrow all the equity he could from the old house first and park it in an interest-bearing account to make certain he’d have the cash to make the down payment on the new house. But it made him nervous to be applying for a mortgage on a new home while having one on the old. The fact that he owned his house made him feel safe. He could always borrow against it if he needed to.

He signed the papers committing to the new house, which called for a down payment of $300,000. A year later the new house is nearing completion, but his old house has been on the market a long time and things have gotten so bad now that no one’s even bothering to come look at it.

If he had taken my advice and borrowed the equity out of his house first, he’d be getting the mortgage-tax deduction on his mortgage payments, and earning money on the cash. But once the house was listed for sale, it became ineligible for a mortgage. The only other possible source for the $300,000 he needs would be to sell some of his stocks. He’ll have a sizable profit on his investments, but a big chunk will be eaten up by taxes.

My client has managed to create a perfect financial storm by following the wrong instinct. Mortgage debt is not a sin, it’s a tool, as long as it’s used for the right reasons and in the right way.

Another client who is already retired has a similar problem. He wants to move to a coastal resort city and needs money for a down payment. His house has lots of equity but he may not be able to sell it and he can’t mortgage the first house to finance the new one. He has a large retirement account, but if he takes any of that money out now, he’s going to get hit with a big tax bill.

My clients are not alone. This same scenario is rippling across the landscape and helping to contribute to America’s real estate gridlock, which is going to get worse before it gets better, and take a long time doing so.

When people fail at managing this most valuable asset, America’s investment jewel-in-the-crown falls apart. That’s why a problem in what was a specialized corner of the market⎯sub-prime loans⎯has had such an enormous impact. It’s not that the economy is so bad that people are losing their jobs and can’t pay their mortgages. It’s that too many people either used their home equity to buy expensive toys and vacations, or left it locked up and now can’t get at it.

As a result, right at the moment when the baby boomers are starting to hit retirement age, wanting to sell their homes and start the next stage of their lives, they’re stuck. The houses that are selling are not fetching what they would have a year or two ago, mortgage standards are higher, and it’s tough to get a mortgage when you’re leaving the job market.

Seventy years after the Great Depression, Americans are still being guided by a fear that has always been misplaced, and bad advice that is still being dished out by advice givers who don’t really understand how money works. In spite of falling real estate values, it’s still true that real estate is the greatest creator of wealth, but not the way most people think.

---

Share this article: