CONVERT THE ''DEAD MONEY'' YOU HAVE IN HOME EQUITY INTO USABLE CASH.
Investing in real estate is exciting and can bring huge returns. But, especially if you are new to the game, you have to be careful about how you allocate funds. By following conventional advice, you may have been making a profound and costly mistake in how you dispose of your money. This all-too-common mistake is in transforming all of your potentially usable cash into equity in your home.
Sadly, most people have taken the wrong advice from the wrong people—people who work for banks and financial institutions, who seemed trustworthy and smart but who have placed the banks' interests above that of their client's.
The banks and financial institutions had it their way for many years. When it came to mortgages, they set the rules. They decided what was good for you. They urged on you mortgage strategies that were designed to help the banks, not investors. They promoted the values that worked best for them, not for investors. They did all this by choosing which mortgage instruments to make available.
No one complained. No one asked if there was a better way of doing things. People went along because—quite frankly—they didn't know any better. After all bank officials dressed nicely, they were young and energetic, they sounded as if they knew what they were talking about. How could one question their advice?
The banks were suggesting that a mortgage had one and only one purpose—and that was to help the borrower pay off the debt on a home conveniently, taking as long as 15 to 30 years to become debt free.
The banks did not think of a mortgage as the driver of wealth creation—as putting usable cash in the pockets of borrowers. That was the last thing on their minds. The banks advised borrowers to pay off their mortgages quickly—and to seek profits, via usable cash, in other investment vehicles only after a mortgage was paid off.
It seemed like good, safe advice. But what it meant was that many borrowers were swallowing whole the bank's philosophy that it was better to have cash tomorrow rather than to have cash today.
What the banks should have been doing was to help people accumulate their own ready-to-use cash. Instead they have done a magnificent job of convincing future real estate investors to turn over their hard-earned income to the banks in the form of enormously high mortgage payments. The size of a mortgage payment depends on how much one borrows (the principal), the length of the loan (its maturity or term), and the interest rate.
It has been the banks that have propagated the belief that you should pay down a mortgage as quickly as possible so that, in older age, you do not have to make monthly mortgage payments. We are not at all sympathetic to such a strategy because it leaves you with very little disposable cash with which to create greater wealth.
Because the banks and other financial institutions have convinced so many people of the wisdom of paying off their mortgages quickly, it is important to spell out why it is so important to have cash in your pocket. For years people paid off their mortgages instead of asking whether it wouldn't be better to have cash available for immediate use. And there are indeed a number of reasons that ready cash is so important.
First of all, the more cash that you have available now, the easier it is for you to purchase items, whether it is food at the grocery store or a piece of real estate. Just as important, the more cash that you have in your pocket, the easier it is to leverage that cash into even larger sums of cash. If you have no cash flow, it would not be possible to build up millions of dollars in value.
By increasing your cash position you can buy more investment property, put more money aside in interest-bearing accounts, and get into the stock market. You can look for better financial terms and more mortgage options.
With all the advantages now afforded both from the banks (who offer compound interest on their accounts) and from the wealth creation that is inherent in real estate appreciation, it simply makes no sense to pour what we call ''dead money'' into monthly mortgage payments.
The money that is poured into these payments is ''dead'' because it is not available for the creation of cash flow and investment. It can of course be accessed theoretically whenever the owner wants to refinance or sell. If the owner sells the property, he or she relinquishes any and all equity in the property. The main point—and people have a hard time understanding this—is that putting the money in other investments will yield more than if the money is used to pay off the mortgage.
Investors should look for advice from those who provide it across the whole gamut of real estate and mortgages. They should look for specialists like ourselves who can suggest ways for the real estate investors to convert the dead money they have ill-advisedly put into home equity, into usable cash.
Here's a practical example of a fellow who came into our office, hoping to refinance some of his properties. We showed him how to convert his dead money into usable cash.
We had refinanced one of his properties about three and a half years earlier. The value of that property was $210,000. Back then he had taken out a $168,000 mortgage on the property with a monthly payment of $786, which was at a pay rate of 3.83%.
But now, when we looked at his situation—taking into account the appreciation in value to $467,000 on his properties—we drew up a new mortgage for $374,000 with a monthly mortgage payment of $945.
The man told us that he owned some other properties on which he had a home equity line. He wanted to extract some money from these properties in order to invest in a business. But he was reluctant to draw down his equity line because the rates had been far more volatile on this line than on other mortgage instruments that he was starting to hear about. We advised him that his reluctance was well founded, that he was quite right not to draw down on the equity line.
We set up a new mortgage arrangement for him. And because of that, he had been able to take $200,000 out of his property (what was left of the $374,000 left him with $206,000 less closing costs as a result of the new mortgage amount). The new mortgage was done within 30 days. If he had been building a new business or making an investment and had needed to act quickly, our advice to him would have been to draw down on the equity line. But because the interest rates on the equity line are so volatile, our advice was that he convert that line of credit into a better mortgage instrument, one that had a less volatile index and had better payment options.
What were some of those better payment options? Chief among them is the ''smart loan.'' The smart loan is a loan that provides for four payment options: a minimum payment option; an interest only payment option; a 15-year amortized payment option; and a 30-year amortized payment option. The loan is ''smart'' because it provides flexibility through these options.
If our client took an interest-only loan, he would pay only $1,083 a month as a mortgage payment. A minimum-payment loan would require him to pay $505 a month in mortgage payments. Thus, it would be to his advantage to take a smart loan, especially if he is setting up a new business, because he would have to pay less per month—either $505 a month or $1,083 a month. If the person took that same $200,000 with a 6% interest rate over a 15-year term, the monthly mortgage payment would be $1,687, obviously a much worse position.
The man who had come into our office really liked the ''smart loan'' options. He was smart to follow advice about these options. You should follow another piece of advice as well: Before you think about buying a piece of property, explore what your options are; find out how much in monthly mortgage payments you will have to make. Project it out for five years. That's a long enough projection because you will probably want to refinance within that period.
We told him there was a very good possibility that he would want to refinance in the not-too-distant future; by doing so, after all, he would be able to take more cash out of the property.
Start with the fact that at this particular time property prices are rather dramatically appreciating on an annual basis; at times there is appreciation on a monthly basis. So it makes a great deal of sense to think about refinancing after five years, perhaps even after three years.
Another advantage of refinancing is this: within the mortgage instrument that we use, at the end of five years, the program goes over to a fully indexed rate. At that point the monthly payment could increase, but not necessarily.
It would make sense then for the borrower to go back to the original monthly payment, by using either the minimum payment or the ''smart loan'' program.
With both the pay rate and the interest rate continuing to drop, you have the opportunity to lower your mortgage payments and increase the amount of cash you are taking out of the property by refinancing. You could then take that money and do something else with it.
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