While many Americans may be breathing a sigh of relief over their increased wealth, rising home and equity values can present unique challenges for advisors and their clients.
Indeed, the wealth effect, or the combined result of increasing home and equity values, can be a double-edged sword. On one hand, Americans may enjoy feeling richer as they move toward reaching their long term savings goals. One the other hand, the increased wealth may cause Americans to live beyond their means and become over leveraged with home equity loans.
Advisors, therefore, have an attractive opportunity to help their clients act prudentially as their personal wealth climbs.
The Challenge
During the years leading up to equity and real estate market peaks of 2000 and 2008, many Americans used their homes as piggybanks by taking out home equity loans to finance car purchases, vacations, home renovations and consumer purchases.
Unfortunately, many Americans became over leveraged and were unable to keep up with their home equity and mortgage payments, leading to an increase in foreclosures. To add insult to injury, as home values declined, many homeowners ended up with home equity and mortgage debt that exceeded the value of their properties, so they were left with nothing to show after having made mortgage payments for years.
Americans with increasing home values and strong equity returns may also be tempted to curtail their retirement planning deferrals. After all, it may appear that wealth being created from real estate and existing equity investments may cancel the need to continue putting money aside for retirement.
The Opportunity
Advisors can use the wealth effect as an opportunity to strengthen relationships with clients by asking investors if they plan on taking out home equity loans and increasing their spending as a result of seeing their personal wealth growth. Advisors should start off by saying that the wealth effect is a positive development but that it should be viewed as something that can contribute to long-term savings goals rather than as a source for financing consumer spending.
With that in mind, advisors should explain to clients that debt can be an important tool for acquiring homes and other big ticket items such as cars. A home equity line of credit can also be helpful for supplementing clients’ savings for emergencies and periods of unintended unemployment.
Yet, debt must be used responsibly, so advisors should discuss the possible hazards of having debt payments that can exceed an individual’s means and make it impossible for individuals to fully fund their retirement programs. Such a discussion is an attractive time to offer to review clients’ budgets. That way advisors can help client assess if they can make additional debt payments and if additional debt will prevent clients from making contributions to retirement savings plans.
Advisors may also want to run scenarios that will illustrate how much debt will cost their clients in the form of interest payments and in the form of missing out on equity gains that may have been realized had clients invested money into the stock market rather than make month debt payments.