Banks should be educating everyone on how to turn mortgages into wealth creators. Instead, they advocate mortgages that have no wealth creation possibilities.
Banks have been advocating taking a 15-year or 30-year fixed rate mortgage as the safest and wisest course of action. The traditional fixed rate mortgage (FRM) has been the standard for many years. It became popular because neither the interest rate nor the monthly payment ever changed over the life of the loan. That allowed the borrower to know from the very beginning precisely how much a mortgage payment would be each month for the entire life of the loan.
For those who place a great value on predictability, the FRM offered just that—predictability and stability. But there was a price for this predictability—a higher interest rate. These longer loans cost more because of the total interest paid. For example, a
$50,000 loan for 30 years at 10% will have monthly payments of $438.79. That means that over 30 years, the borrower will have paid $107,964 in interest—more than twice the amount of the loan.
The same loan for 20 years would have monthly payments of $482.51 (an extra $44 per month), but the total interest paid will be only $65,802—a long-term savings of $42,162, if the borrower can afford the extra $44 per month.
Banks charge a higher rate of interest in order to offset the risk that at some point during the life of the loan interest rates will rise. Since the banks would not be allowed to raise the interest rate on your loan, according to the terms of that loan, the banks lower the risk of losing out on the profit from higher interest rates by charging a higher interest rate.
Still, it is fair to say that the FRM is the single worst mortgage in creation.
Why say this? First, because the only one that benefits is the banks. And second, because all you are doing is giving the bank your cash flow, year after year.
The banks essentially get free money in the form of principal payments. Perhaps that is why these 15-year and 30-year fixed mortgages are increasingly in disfavor. Following our philosophy, you have to abhor all these long-range mortgages because, we believe, you should view your home as a wealth-building tool.
We run into the ''victims'' of the banks all the time. These are the people who own a home worth over $1 million and have barely enough money to buy food. Certainly you would think there was a happy solution for them. Unfortunately, however, for some of them this is not the case. Because of their age and their income level, they no longer qualify for the mortgage instruments as they would have when they were younger. In their younger years, when they had sufficient cash and earning power to save money and put it into a convertible cash instrument, they failed to take such a step.
As a result, in their later years they are unable to convert any of the equity they have built up into some kind of a cash item without doing a reverse mortgage, which we don't think is the best kind of mortgage instrument.
You'd be surprised how many people today have made very little preparation for their retirement and don't really know what to do. But they love the real estate boom and the possibilities that it holds out for them. They want to purchase as much property as possible. But they don't quite know how to do that.
They find the whole world of real estate complicated and they're not sure of where or how to invest their savings in that world. There's far more to real estate than simply buying into the latest condominium building and hoping to get out of the investment with some profit. If investors become part of that kind of herd mentality, they will get trampled.
WITH THE CASH YOU SAVE BY PAYING A LOWER MONTHLY MORTGAGE PAYMENT, LOOK FOR WEALTH-CREATION STRATEGIES THROUGH REAL ESTATE VENTURES.
People with a million dollars of equity in their homes but not enough cash to pay for their food must learn that the objective is not to pay off their debt. The objective is to have the amount of money needed to pay off the entire mortgage—but to use part of that money for wealth creation.
Think of your financial situation as a portrait of your assets and liabilities. If you have a lot of money stuck in equity, you have to consider that a liability. Your goal is to move some of the non-earning, illiquid assets from your liability column into your asset column, where your liquid, usable cash is listed.
So at the end of the day, when you look at the liability side, and it says you have $200,000 worth of debt and your asset side says you have the same $200,000, you can use the funds on the asset side to eliminate your debt at any time. That's a desirable position in which to find yourself, but it's not your real objective: your real objective is to leverage the money on the asset side into greater and greater wealth.
To fully appreciate how important it is to achieve a situation where you can have the assets available to create wealth, you have to understand the ''time use of money.'' Once you understand that, you will be able to convert illiquid, non-earning equity into usable cash. The time use of money is the value over time of the money you use today. Evaluating the time use of money means taking into account taxes, inflation, compounding, and a bunch of other factors, especially the potential for leverage, when thinking about the use of money over a period of time.
We meet people all the time who keep pouring all of their cash into their homes. One person we met recently had a classic problem. He owned two pieces of property apart from his home. For the first he had paid $170,000 and it had climbed in value to $300,000. For the second he had paid $186,000 and its value had jumped to $280,000. He wanted to sell these two properties and use the proceeds to pay off his home, which was worth $500,000, and on which he owed $400,000.
We explained to him that that was the worst thing he could do.
His big problem was that he had equity in these two properties but he didn't have any cash. He was cash poor and house rich.
This is an issue for many people who are running out of cash. They start thinking about downsizing. They are holding properties that have great wealth, but that wealth is locked in and they can't put the money to work for them. For this client, selling the properties was not the answer. The answer was a different mortgage type, the kinds we explain in later chapters.
Here's an example of another house-rich and cash-poor family: A couple owns a house that is now worth $500,000. It's totally paid off, although they are still paying taxes, insurance, and maintenance. They have little or no cash and came to us wanting to take cash out of the property. Their property has appreciated dramatically over the years, but they have never taken cash out of it.
They had a false sense of security, because their house is paid off. While they can claim a certain security, they have left themselves few financial opportunities. They have no real cash flow to help them take care of their normal living expenses. That's why they came to us. We set them up in one of our New Smart Loan™ programs, and they were grateful. Now they had money for their daily expenses. Soon they might be able to put enough money away for investment purposes. It was not too late for them to change their way of thinking and start leveraging their money.
With their home valued at $500,000 they were able to refinance for $400,000, with a monthly payment of $1,517. Now they have $400,000 available to themselves in cash. As long as they have a good credit rating, they have the opportunity to put that usable cash into one or more real estate opportunities.
STRATEGY # 10:
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Discover the Jealously Guarded Insights of Real Estate Tycoons and Hot Dealers! Back in the days of the wild, Wild West, when easterners traveled across this vast country looking for opportunity in the newly opened territories, they were often referred to as a ‘tenderfoot’.