Strategic Equity Program
Nobody wants a mortgage. We’d all love to pay cash for our houses but that’s an impractical wish. It’s the biggest check you write each month and life would be so much easier if you didn’t have to write it.
However the best strategy for building wealth is to never own it outright and never pay it off. When
I bought Ric Edelman’s book “Ordinary People, Extraordinary Wealth,” I was amazed that the first of his eight
secrets for building wealth was about his wealthy clients who carry a mortgage even though they could afford
to pay it off. That certainly means to me that it is one of the most important steps in building wealth.
In another publication he gives 10 reasons why his financial counsel is to carry a 30 year mortgage and never pay it off.
- Your mortgage doesn’t affect the value of your home. Your home’s value is market-driven, not mortgage-driven, and will rise or fall in market value whether or not you have a mortgage.
- Your home will build equity, with or without a mortgage. Trying to build equity by paying off the mortgage produces weak results.
- A mortgage is cheap money, the cheapest you can borrow in any market.
- Mortgage interest is tax deductible, and since it’s the cheapest you can get, get as much of it as you can.
- Interest on your mortgage is tax-favorable. A mortgage is deductible at your top tax bracket, but investment income is taxed at 15 percent.
- The payments get easier over time. I’m in my 5th house ad in each case the payment got easier. Income rises, but a fixed rate payment stays the same.
- You can capture your asset growth by borrowing it rather than selling it.
- A large mortgage allows you to invest money more quickly.
- Build wealth with a long-term mortgage. It allows you to invest more.
- Mortgages give you greater liquidity and flexibility. Once you’ve paid on your mortgage that money is locked up by the lender and doesn’t earn you a dime, and is no longer available to you. By putting it in an investment account, it’s always available to you when you need it.
In his “The New Rules of Money,” he tells the story of two brothers, each of whom secures a mortgage to buy a $200,000 house. Each earns $70,000 a year and has $40,000 in savings.
Brother A believes in the traditional way of paying off a mortgage as soon as possible. He secures a 15-year mortgage at 6.38% APR and shells out all $40,000 of his savings as a 20% down payment. His payment is $1,383. At his 32% tax bracket, his after tax cost is $1,227. He also sends in $100 additional principal each month.
Brother B subscribes to the new way of mortgage planning. He secures a 30-year interest-only loan at 7.42 APR and makes a 5% down payment of $10,000 and invests the remaining $30,000 in a safe investment that earns 8%. His monthly payment is $1,175 which is totally tax-deductible during the first 15 years of the loan, leaving an after-tax cost of $799. He also adds $100 a month to his investments along with the $428 savings from the lower payment.
After five years, “A” has received $14,216 in tax savings, “B” has received $22,557 in tax savings and his savings and investment account has grown to $83,513.
What happens if both brothers lose their jobs? “A” has $74,320 in home equity but with no job he can’t get a loan. He can’t make his payments so to avoid foreclosure he has to sell his house – a fire sale. “B” has $83,513 in savings so he can make his payment for years, if necessary.
Assume neither lost their job, how do their situations compare after 15 years? “A” has received $25,080 in tax savings and has $30,421 in savings and investments (He’s saving the equivalent mortgage payment each month and owns his home outright.)
“B” has received $67,670 in tax savings and has $282,019 in savings and investments. He can pay off his $190,000 mortgage and have $92,019 left over.
After 30 years, “A” has $25, 080 in tax savings and $613,858 in savings and investments. “B” has received $107,826 in tax savings and has $1,115,425 in savings and investments and could own his home free and clear but still chooses not to do so. He has the ability to pay it off at any time he decides.
“B” obviously had a better strategy for his equity.
