Tuesday, January 10, 2006

Borrow Low Invest High

Well this is going to be fun, although I probably wont have enough time to spend making this the coolest site, I did want to make a page of referance for some of my thoughts. For starters... due to some negative comments that I have heard both in jest and not, I wanted to spend some time clearing a few things up. I really enjoy my job, and it is as legit as it gets. This has been a great career move, and beleive it will continue to be so. I wanted to share some knowledge that I have gained over the last 6 months, and especially for those of you who own homes or are looking to buy a home this is invaluable information, and you will be far far far ahead financially if you practice some of our strategies. This is not an attempt to convince any of you to refinance your home with me. I feel like this is the best financial strategy for financing a home. I have decided that I will probably not be doing a loan for anyone that I feel close to because of all the underlying implications that come with doing business. But this is good information, and please use me as a reference source anytime you have a question, about anything. I am going to give some warnigs, suggestions, and teach some of you what people in this idustry know, but don't tell consumers.

The following story is typical for most home buyers.

Mr. and Mrs. Miller buy their home for $300,000 with a 30-year fixed mortgage loan at 6%. Five years later, with help of a local real estate broker, they sell their home for $380,000. “See, honey?” Mr. Miller says to his wife, “We did well. Five years ago, we picked out a good house in the right neighborhood, paid the right price and we just made $80,000 profit!”

Mutual congratulations in order, the Millers are happy. And, so is their lender. Why? Because their lender’s game just worked successfully on yet another borrower. In fact, it worked so well that The Miller’s are about to purchase a new home with a 30-year fixed mortgage loan and start the process all over again!

The Millers think that owning a home (their biggest investment) has been profitable.
They have $80,000 profit to prove it. Unfortunately, the Millers have LOST money. Over the last five years, they made 60 payments of $1798.66, totaling $108,000 to their lender. Only $21,000 went to principal. So, they paid a whopping $87,000 in interest! Yet, their house only increased $80,000 in value.

The Millers might have sold their home for $80,000 more than they paid for it, but they paid $87,000 in interest to the bank! A $7,000 loss!. And, factoring in the customary 6% cost associated with selling a house (in this case $22,800), we arrive at a grand total of $29,800! What was supposed to be the Millers’ biggest, best and most important investment created a $29,800 LOSS! Perhaps the worst part of it all is that the Millers are under the impression that they made money!

So where did they go wrong? The mindset begins with what our parents and their parents tought us. Which is... Pay off your home as quickly and cost effectlvley as possible. Fine. So, is a 30 yr fixed the best loan for that? The most common question I hear is,"what are the rates right now? I want the lowest fixed rate you can give me." Most knuckleheaded loan officers don't educate their clients on what they are doing. A 30 yr fixed loan is beneficial to one entity... the Bank. How does that work?... Here are some quick Facts:

The average American relocates, refinances, moves upgrade/downgrade, every 5 years.
About 65% of Americans own homes, 5% of those ever pay off their mortgage.
Im sure you are all familiar with the amoritization schedule of a fixed rate mortgage. If not, here is how it works, for the first five years of your 30 year term, about 5% of your monthly payment goes towards your principle, and the rest to intrest. Unless you stay in the loan for the entire term that fixed rate doesnt even apply. The only benefit to a lower rate is a lower monthly payment. These loans are front end interest loaded, that is why only 5% of Americans pay off their home, every 5 years they sign on a mortgage that puts them back to day 1, and Americans never pay more than 5-10% towards their principle balance. Based on the facts, this sound, safe, conservative approach is very inneffective.
Alan Greenspan, 2/23/2004, Governmental Affairs Conference-

“Recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than traditional fixed-rate mortgages.”

“American consumers might benefit if lenders provide greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.”
So although a conventional approach sounds more secure, safe, and smart... is it really the most effective method? Here is a small excert from David and Tom Gardner, who in 1993 founded the Motley Fool, an enterprise that now includes a Web site ( with 2.2 million members, an NPR radio show and a column syndicated in more than 200 newspapers.
Conventional thinking: You should pay off your mortgage as soon as possible.
Smart Foolish thinking: David: "Why? Although it's a good Foolish rule of thumb to pay off your debts, not all debt is created equal. For most of us, the mortgage is the biggest debt we have. We instinctively want to attack it when we have the income stream to do it. But it's the structure, not the size, of the debt that matters. It's very likely that your mortgage rate is less than half of the rate on your credit card. And the mortgage interest is tax-deductible. After the tax advantage, you may very well be paying less than 5% on your mortgage rate. That's a good interest rate." Tom: "You also can put the money to better use by investing instead of paying off the house.
"Now, many who feel compelled to pay off the house above everything else argue that it is an investment. They also could very well be the types who believe you need to buy as much house as you qualify for, with respect to the loan. But that's not good Foolish thinking, either. Sure, a house is a great investment. But it's not liquid, like a mutual fund. And the bigger your house, the bigger the payments are that don't translate into return: utility bills, maintenance and all of that 'stuff' you need to fill up all those rooms. Your total monthly bill for maintaining the house -- mortgage, utilities, insurance and everything else -- should eat up no more than 30% of your monthly income."
So on to my next point, how much would you deposit in the following investment account?

· The customer determines the amount and length of time for monthly contributions to continue.
· The customer can pay more than the minimum monthly contribution, but not less.
· If the customer attempts to pay less, the financial institution keeps all of the contributions.
· The money deposited in the account is not safe from loss from principal.
· Each contribution made to the account results in less safety.
· The money in the account is not liquid.
· The money in the account earns 0% rate of return.
· The customer’s income tax liability increases with each contribution.
· When the plan is fully funded, there is no income paid out.
Paying the principle portion of your monthly payment to the bank by definition, is a bad investment. So what can we learn from the bank? Where do they get their money? the Fed, and from us. And what do they do with it? Invest. So why do we give them the money that we could be earning interest on ourselves? If you pay that amount monthly and put it into an investment account, if your goal is to pay off your home, you will have the equivelent of your mortgage balance in cash, much faster than 30 yrs.
Borrow Low Invest High, that is the name of the game for anyone effectively accumulating wealth.
"There are three kinds of people in the world: Those who pay interest, those who earn interest, and those who pay interest in order to earn greater interest." - Douglas R. Andrew "Missed Fortune"
Through leverage you can use your home as it was intended, as an investment. Sean and I have argued this point, and I have got to go with the prophet on this one...
"The Church has no debt. I qualify that to the extent that we have some contracts for the purchase of properties where the sellers insist on payments over a period of time. There are resources to ensure that these contracts will be covered in a timely way.
In our few business enterprises, some debt is used as a tool of management. But the ratio of debt to assets would be envied by the executives of any large organization.
The Church has been living within its means, and it will continue to do so."
Recently I had a conversation with a man who had over $300,000 in liquid investments, he had inquired about refinancing a $215,000 mortgage. He was trying to decide whether to pay off his home or not. So I asked him why he hadnt done it yet. We both knew the answer, the cash was more valuable to him liquid and compounding, then tied up in his home, and he needed the tax deduction. Interest paid on a mortgage is a dollar for dollar tax write off. Because he has a good credit score, and has proven his financial aptitude, the bank will cater to this guy. They will give him as low as 1%, interest only, so that he can continue leveraging this property. Because a lender will prefer a small payment as opposed to none at all. If you need it, they wont give it to you, and if you dont need it, they are giving it away.
If I lost my job, and couldnt make my payment, would the bank be more likely to foreclose on me if I had a $200,000 home with lots of equity or none at all? If I owed $100,000 on this house the bank would foreclose on me the first chance they had, because they could sell the house for half the price and walk away without a loss. If I leverage my home I for one, would be less likely to not make a payment beetween jobs because I would have that money available to me, but if I for some reason couldnt make my payments, then the bank would find me a job, because they will be the ones to pay the debt, and they dont like to lose money. So this method is more secure, and safe, if you are talking about being able to keep your home.
I think I could add a few other references and examples of how this strategy can be effective. Bottom line is, no matter what the scenario, the math cannot be argued. This company has ten years of experience and research to back the principles that it teaches. We have several financial advisors, investment gurus, and many a wealthy client that live by this philosophy. We do not market a specific client, but our average loan size is $500,000, our average client has a net worth of $1.5 million with an average credit score of 740. I dont bring that up to boast, but to point out the type of person that agrees with this method of financing a home.
Thanks for your time, I hope this is helpful.