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The 1 Percent “CASH FLOW ARM” MORTGAGE

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : April 17, 2006

What kind of loan do you have on your house? The vast majority of clients around the country have 15 to 30 year fixed mortgages. The question is “why?” The answer is fairly simple: Clients do not know the mortgage topic well, and their “local” advisors (especially those that work inside banks) typically refer what they know well which is the 15 to 30 year mortgage.

Many more affluent clients choose a 15-year loan as their loan of choice. Why? So the client can pay off the house early. The logic is flawed and does not protect the client.

Have you ever heard of a 40-year amortization loan?
Would you want one? The answer is probably that you have not, and that you wouldn’t want one. Should you? Absolutely. Why? Protection purposes. If something financially goes wrong in your life (disability, loss of job) you want a loan that “requires” you to make the lowest possible payment. That is the 40-year amortization loan. You can still pay the loan as if it were a 30 or 15 year loan, but you have the option of paying it at the minimum rate which would be based over 40 years.

What about the 1% cash flow arm (CFA) mortgage?
Have you ever heard of one? Probably not. Why? Because you can’t get one from your local bank; most mortgage brokers don’t know what they are; and the ones that do, do not understand how they work or how to explain it to you.

The 1% CFA is my favorite kind of loan for the “right” client. Who is the right client? NOT someone who can barely afford to stay in their home and needs to use this loan to drop the payments in order to stay in the house.

The 1% CFA is for clients who have money and would like to use the mortgage deduction coupled with a tax favorable or tax free investment to build a large retirement nest egg.

Here is a brief summary of how the 1% CFA mortgage works.
1) The client’s payments are based on a 1% mortgage rate.

2) The client’s actual interest rate that he/she is being charged is pegged to an index such as LIBOR, plus a fee the bank throws in to make some money as well.

When you add the index rate plus what the bank makes (called the margin) you have what is called the fully indexed rate (which is the actual interest rate of the loan).

If the index is 2.25% and LIBOR is 4%, then the fully indexed rate would be 6.25%. This is the actual amount of interest being charged to the loan.

At first blush, people will see that while it is nice to have a pay rate based on 1%, they don’t like the fact that there will be deferred interest due at some point. (This is a 5 year ARM and the interest would be due at the end of the 5th year.) Having said that, people who use this loan correctly will refinance every 3 to 5 years back into the 1% arm (including any deferred interest).

For a detailed explanation of how the 1% CFA mortgage works, please e-mail us at info@trustmakers.com.

Why would someone want to use the 1% CFA mortgage? It’s simple. Answer me this question: Would you like to borrow money, be able to write off the interest and invest it in something that would grow tax free and come out tax free in retirement? Your answer should be "absolutely."

The 1% CFA mortgage is the best option for people looking to raise the maximum amount of money to invest each year for retirement. The goal, as strange as it sounds, is to never pay off the home and to build a tax favorable retirement pool with the money that would have been used to pay down the house. Remember these two things:

1) Your house will appreciate whether it has debt on it or not.

2) The appreciation on the house in most parts of the country should cover the deferred interest due on the loan when it is eventually paid off.

Let’s simply look at the numbers. They are very powerful and speak for themselves.

For the following example, assume a client (male, age 42) has a $400,000 mortgage on a home with a fair market value (FMV) of $500,000. The first chart shows what will happen to the client’s home mortgage payments with a 1% arm vs. a 6% 30 year conventional loan. The amortization with the 1% arm is 40 years.

With the 1% arm, the client freed up $73,395 of cash flow over the five year window.

If the client took the money saved from the first five years and invested it into an equity indexed life insurance policy earning 7.9% a year, the client could take out of his life insurance policy $22,000 a year income tax free from age 63-82.

Remember the numbers above are simply from the savings on payments from the first five years. Also remember that the client is writing off the interest on the loan.

Equity Harvesting

Would a client refinance a property if he could have payments on a 1% loan and invest the borrowed money in a tax favorable environment? Many would say "yes."

Example: Assume a client has a $1,000,000 home with no debt or very little debt. Assume the client decides to sell the home and buy a new home. In that process, assume that he removed $600,000 of equity from the sale of the home and invested it for retirement income later. Assume the client used the 1% cash flow arm and is in the 40% tax bracket.

The following would be the interest payments on the loan for the first five years:

If the client invested the $600,000 into an equity indexed life insurance policy earning 7.9%, the client could take out of the life insurance policy $191,000 income tax free for 20 years starting at age 63.

So again, the question is, would you or your clients like to use a 1% arm to build wealth for retirement? Most clients with equity in their houses will say "yes" and will want to lower their current mortgage payments and invest the difference in order to build more wealth for retirement.

Summary
The 1% CFA is not for everyone, just for those who have some wealth and are looking to raise the maximum amount of money NOW to build a tax favorable retirement nest egg. If your goal is to have no debt or if you can not understand the math of this concept, then a 1% CFA is not for you.

For help to determine if a 1% CFA is right for you, please e-mail info@trustmakers.com.

If you would like to purchase the 9 page education module on how to protect the marital home, please Click Here.

If you would like to purchase the education module on the 1% cash flow arm mortgage program and equity harvesting/equity stripping (which will be covered in a cursory manner in the upcoming newsletter), please Click Here. .

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