Do you work for your mortgage or does it work for you?

Date : 13-March-2007

Dear Subscriber:

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 necessarily 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 they don’t have money to live on, and they no longer have tax deductions to offset their retirement income which 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 a 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 cost or market indexes. Fixed percentage points (the “Margin”) are added to the index and establish 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. Fortunately, I’ve had the ability to create proprietary loan products that are designed specifically for our investors that slow down the acceleration of recast. Many advisors only have what is common and on the shelf to plan with.

There are two kinds of people who hate mortgages: those who fear them, and those who believe that mortgages cost you huge amounts of money in interest charges. We've already resolved the former issue, that fear thing, so let me dispel the myths surrounding the interest question.

Carrying a mortgage doesn't 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% (depending on the 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.

Don't worry about 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. 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.

So, Lets Review…
1) You get no tax break when giving 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 rule applies.

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 ridiculously apparent, you haven't come across any of the thousands of consumers who 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 bills. Talk about a bizarre strategy! These folks are struggling to give the bank all their money now merely so they can borrow it in the future! Why don't they just invest their cash so that it earns competitive returns and 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. That's why you should 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 utmost. 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 everytime even if you only earn 5% on the money. In other words, the simple interest on the lending side is more than what you initially earn. With time and compound interest you still prevail.

The most important reason you don't want to give the bank any more money than necessary is because Cash Is King. Having a home fully paid for is one thing, but being able to cover that unexpected medical expense is another. You'll need cash to pay for a family member's wedding, start a business, to send a kid to college, or just bail someone out of jail. If you lose your job, not owing the bank any money on your house will be small comfort when they repossess your car because you’re house rich and cash-poor!

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.

FOR MORE INFORMATION GO TO: info@trustmakers.com

“The Best Rate on the Wrong Strategy Can Cost More Money Than a Bad Rate.”

“What’s Your Mortgage Strategy?”

James Burns, Esq.