Do You Work For Your Mortgage Or Does It Work For You?

“DO YOU WORK FOR YOUR MORTGAGE
OR DOES YOUR MORTGAGE WORK FOR YOU?”

By
James Burns, Esq.

Here's an important lesson all wealthy people understand: No one ever got rich just by saving money. Or, put another way, paying off debt is not the same as accumulating assets. I stress this because many people think they will be better off financially if they eliminate their mortgage. But this is not automatically true. Despite the fact that millions of Americans believe this to be true, does not make it true as many have been ill advised and you need to know why.

It was once rational to fear your mortgage. Mortgage-anxiety, is rooted in a harmful event referred to as a “mortgage call.” This contract provision allowed banks to call a loan due in full, at anytime, without cause and with only thirty days notice! During the Great Depression, banks called countless loans due in a desperate attempt to recapitalize. Consequently, few people could respond with the cash for the entire loan and the banks foreclosed on millions of homeowners regardless of whether or not payments were current. Fortunately, the banking industry abandoned this “Call” feature decades ago. Despite protective mechanisms in place to avoid a similar event and the passage of some seventy years, Mortgage-anxiety remains and seems to be passed on from generation to generation like tradition. My parents paid off their home in time for retirement so I must do the same is the thinking. Never mind the lack of money to live on and the loss of tax deductions to offset retirement income that is taxed as ordinary income. Does this really sound like a wise proposal to aspire to?

Today the mortgage industry has tools to create wealth like never before, the sophisticated consumer demands nothing less. There are a number of Pick-a-payment Mortgages (aka Option Arms) that create opportunity when used with confidence and purpose. This type of mortgage product allows you to choose between four payment options each month. The options are a 30-year payment, a 15-year payment, interest only or minimum monthly payment, which has a low start rate (currently 1.0 % to 4.95% depending on the homeowner’s, credit, income and other market factors). You can match your loan payments to your variable or seasonal income and begin using the saved income to create wealth. They even have 40-year payment plans but these need to be evaluated carefully as sometimes these products have been proven to be nothing more than hype with no real planning efficacy.

Options Arms use a monthly Adjustable Rate concept to determine the actual rate of interest charged. The loan is linked to one of various indexes like the Cost of Funds Index (COFI), Certificate of Deposit Index (CODI), and Cost of Savings Index (COSI) which are cost indexes and less volatile as opposed to the Monthly Treasury Average (MTA), or the London Interbank Offered Rate (LIBOR) which are market indexes and subject to the volatility of the market. A loan consultant can determine the index and program that best fits your individual financial situation. Fixed percentage points (the "Margin") are added to the index and establishes your effective interest rate and monthly payment. It is wise to understand the recast period and note rider because using the minimum payment defers interest and principal and increases the size of the loan. Many foolish advisors are putting people on the wrong index or with the wrong bank because they don’t know enough to examine the note riders. There is now a 5-year fixed hybrid loan that locks in the note rate to slow defferal and is a great loan for the investment minded person.

In looking at our clients there appears to be two types that hate mortgages: those who fear them and those who believe that mortgages cost them huge amounts of money in interest charges. We've already resolved the fear issue, so let me dismiss the myths surrounding the interest question.

Carrying a mortgage does not cause you to lose any money at all. In fact, just the opposite is true: carrying a mortgage can be quite profitable, while eliminating the mortgage can force you to give up profitable opportunities. If you value asset protection you’ll get the equity out of your home and place it where it is not desirable for a creditor to access it.

This second group of people, the ones who hate rather than fear mortgages, hate them because they know over the life of a 30-year loan; they will spend much more on interest than the purchase price of the house.

EXAMPLE:

Jane is going with a 30-year loan; she will spend nearly $159,000 in interest (plus $120,000 in principal) on a house that cost $120,000. You want to save money in interest, so to minimize your costs; you take all the steps to pay the mortgage off early. Then, with that issue resolved you start to focus on retirement and do your best to save regularly. As a result, you’ll fail to accumulate wealth and can't figure out why.

The reason is simple but not often clear. By tackling the mortgage issue first and your retirement goals second; you fail to consider the role that a mortgage plays in building wealth. You won the battle to reduce interest but the wealth accumulation war is lost.

Here's why!

You know that by reducing the mortgage payment, or even paying off the mortgage completely, you save lots of money in interest charges. While that is correct, you are ignoring another, equally critical fact: Every extra dollar you give the bank on principal, is a dollar you did not invest.

This is a critical point. Mortgages today cost 7.5% to 8.5% (depends on credit score). Over the next 30 years, on an average annual basis, can investments earn at least that much? Absolutely. Even long-term government bonds pay nearly that amount, and non-speculative stocks have been averaging 11.2% since 1926, with the exception of a few recent years. But giving your money to the bank to avoid a 7% to 8% simple interest charge denies yourself the opportunity to invest that money where it might earn 9 to 10% tax deferred at compound interest. Therefore, by looking at individual trees, you fail to see the forest because simple interest and compound interest carry very different results over time.

EXAMPLE:

Rob has a low rate $132,000 first mortgage on his home that is worth $285,000 dollars. Since Rob works with a professional advisor, he decided to get a home equity line (HELOC) for $70,000 at 5% and invest it through his advisor in a tax advantaged savings account with a guaranteed product that has consistently produced at least a 8% growth annually and has principal protection. The $70,000 investment with an 8%+ override will make a significant contribution to Rob’s retirement, especially once compound interest kicks in. Even if your borrowed mortgage money is 8%, you’ll win every time if you understand the economics.

The irony is that some people feel they are making a good "investment" by paying off their home loan. You need to remember that your home will grow in value over the next 30 years (national average is over 6% per year), whether you have a mortgage or not.

Think about it. When you sell your house, does any buyer care what your mortgage balance is? Of course not. Neither does the IRS when you calculate your taxable gain or loss. The simple truth is that mortgages do not affect home values.

Therefore, you have a choice. You can pay cash to buy a $200,000 house, enabling you to own it outright, or you can buy that house with 20% down. Let's explore each of these scenarios and see which is better at helping you achieve your true goal of accumulating wealth.

So don't fret about all the interest. Focus instead on investing and all the money you're able to earn as a result of not giving all your money to the bank. But if this monthly payment is still bothering you, let's do some time traveling. You'll see how much FUN it is to carry a mortgage. In 1970, homes cost an average of $23,400 and 30-year fixed-rate mortgage was 6%. The monthly payment, assuming no money down: $140.

Also, remember that the average monthly income back then was just $646. In other words, that $140 mortgage was as challenging to people then as your $1,000, payment is to you now. And in 20 years, you'll be teasing your kids about your "low" payment because incomes and housing prices will be much higher - just as today's wages and prices are much higher than those in 1970!

It's also very important to remember that mortgage payments get cheaper over time (even though they never actually change), because the payment amounts are fixed while your income grows. So don't worry about your big payment. It won't seem big forever.

For all these reasons, the 30-year mortgage is better than one that you pay off in just 15 years (or a 40 year could be better than a 30 year). It also explains why bi¬weekly mortgage plans are not great ideas unless you insist on paying the mortgage early! You see, the more you pay in principal and the quicker you pay off your loan, the less you have to invest. If you don’t know how long you’re going to be in the property and have an eye on moving up, you should use a tool that allows you to make a minimum payment.

Some readers will be skeptical of this example. They will claim that Julia can invest $824 per month more than Jean, because Jean is making a mortgage payment that Julia has avoided, and that this advantage will enable Julia to accumulate more money than Jean over 30 years. Sorry, but that's not true. Even though Julia can invest $824 per month, Jean gets to invest $160,000 right now. And the results: By investing $824 per month at 10% per year for 30 years, Julia would have $1.86 million. But by investing $160,000 today for the next 30 years, also at 10% per year, Jean will have $3.17 million - far more than Julia will. No matter how you handle it, carrying a mortgage enables you to produce greater wealth.

So, Lets Review…

1) You get no tax break when paying the bank principal. You save on taxes only when you pay interest or if using a minimum payment with a Pick-a-Payment mortgage, the imputed interest.

2) Money you invest is taxed at a lower rate than your savings from tax-deductible interest. Therefore, you want to maximize your interest payment while minimizing your principal payment.

3) Money you give to the bank is money you'll never see again—unless you refinance. If you think this notion is evident, thousands of consumers report that the reason they're hurrying to pay off their mortgages is so they’ll be able to borrow against the equity later to pay their kids' college tuition. Talk about a wacky strategy! These folks are struggling to give the bank all their money now merely so they can borrow it in the future! They should be investing their cash to earn competitive returns, eliminate inclusion by financial aid at the college (certain assets are outside the inclusion formulas) that remains available for use whenever needed?

4) You don’t earn any interest on your equity and when you need it, it might not be available to you. If you ever suffer a job loss, major medical, home destruction (Katrina) or other financial crisis, you could find yourself unable to get a home loan. That's because lenders don't like to lend money if you are in financial difficulty. It is really more conservative to get a big mortgage now, before you need it - while you still can.

5) The best way to achieve a “free & clear” title, if you really want it, is by mortgaging your home to the maximum allowable by your income. Increasing the loan, investing the equity and then accumulating enough to pay off the debt is possibly the quickest method to eliminate a mortgage. Modest assumptions show it to be much faster than a 15-year mortgage that sends more money to the bank.

6) Mortgages don’t lower home values. Your house will grow in value (or not) whether or not you have a mortgage. In fact, most people discover that, over time, their mortgage balance falls while their home value rises - creating substantial wealth they never expected.

7) Your mortgage is the cheapest money you’ll ever buy. Most people need to borrow money during their lives, so why pay 22% to credit cards when you can borrow at rates of 8% or even less? Using this money for investments, not speculation like the stock market will allow you to arbitrage these dollars. When you consider what an effective interest rate is and place that side-by-side with compound interest, you can win every time even if you only earn less on the money than you pay for it initially. In other words, the simple interest on the lending side will be defeated by the compound interest on the investing side over time.

If nothing else convinces you, consider this: my clients are among the most financially successful Americans. They carry a mortgage confidently and with purpose. If you want to build wealth like they do, it's time you start managing your money the way they do. Starting with your mortgage.

The Critical Component!

You can see the path – but how do you get there? It’s available, but it takes SELF -DISCIPLINE and a financial strategy, plus high-quality investment advice.

“The Best Rate on the Wrong Strategy Can Cost As Much Money as a Bad Rate”

If you don’t have an asset protection and financial strategy using your mortgage, we invite you to contact Legal Wealth Conduit and start strategically planning your future and your retirement.

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James Burns
Attorney at Law
Strategic Wealth Team
"The Complete Solution"
18662 MacArthur Blvd.,
2nd Floor
Irvine, CA. 92612
www.houseofdollars.com
PH: (949) 440-3243
Fax: (714) 464-4448