Why You Shouldn’t Pay Off Your Mortgage Early – Episode 251

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[00:03] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, best-selling author, Kim D.H. Butler. Welcome to another episode of the Prosperity Podcast. My name is Spencer Shaw and I’m here with Kim Butler and today we’re going to be talking about real estate. And we’re going to bust a myth in real estate that happens to be one of the most pervasive lies. And hopefully by the end of this episode, you’re going to see, maybe have an aha moment and say, I’ve been doing this wrong. Now I know the right way. So let’s talk about this real estate myth, Kim. So this is the desire that so many people have to pay off mortgages early.

[00:59] And I want to tell a funny story first on the investment side. So not your own home, but when you have a real estate investment. This is credited from Jimmy Vreeland of Joint Ops Properties, where he meets with lots of real estate investors. And it’s really funny because they have a desire to put as little money down as possible, which is great. This is how it should happen in my mind. The best way to make an investment was as little of your own money as possible using other people’s money, whether it’s the insurance company’s money or the bank’s money or what have you. But then they want to turn around and prepay the mortgage. And that makes absolutely no sense. They’re they’re wanting to buy the property with high leverage, but then they

[01:50] want to own the property with low leverage. And it’s completely opposite. It totally is. You know, when I went through truth training and for our listeners that are unfamiliar with the term truth training, you can find out about that at TruthConcepts.com. And truth training is, we’ll say, an information overload to understand the real data behind loans and insurance. And you’re just looking at the financial calculations. That was the training that changed my financial mind. See, I’ve owned a real estate. I owned a real estate brokerage and investment company, and I’ve owned real estate for years and years and years. And I was always focused on getting that sucker paid off as fast as possible.

[02:42] And I no longer believe that. And there’s one big thing that was the ah-ha to me. And it was this scenario. Imagine you have a 30 year mortgage and you’re ambitious and you’re making extra payments every single year. And sometimes you might even be making bimonthly payments. And let’s say you’ve done that for the next 18 years and you’ll have it paid off by a year 20. So you got two years left, almost time to celebrate. And then you fall upon some type of hardship and you can’t work. How are you going to deal with that? You can’t call the mortgage company and ask for an extension because they certainly won’t do it. And in order to get cash out of the property, you either have to get a home equity loan and or you have to sell the property.

[03:32] Well, the bank doesn’t give home equities to people that don’t have income. So you lose all control, you lose all access, game over, reset. So that’s what changed it for me. Now, maybe you can help our listeners understand this myth a little bit more. Absolutely. Well, I think, first of all, we need to identify that sometimes there is a peace of mind that will override financial decision making. And so without a doubt, I want to just put forth that if your peace of mind is so important and to you, it says the mortgage must be paid off and we’re probably talking not investment property here, but your own primary residence, then that’s fine. If your doctor bills are going to be so high because you have stress,

[04:20] because you have a mortgage and you have the ability to pay off the mortgage, then that’s a choice that you make. But if you’re looking at pure financial efficiency, we need to understand that whether it’s investment property or our own primary residence, the most efficient strategy is to have a 30 year mortgage, ideally at a fixed interest rate and to make only the minimum payment required. In fact, in the days when you could get interest only mortgages, and I do understand they might be coming back around again, then that can be effective too, because the 30 year mortgage that is occasionally refinanced, depending on interest rates, to a brand new 30 year mortgage and then refinanced again to another brand new 30 year mortgage over one’s

[05:11] life is truly the best. And I will state that I believe this so firmly that I wouldn’t mind taking out a brand new mortgage when I was 80 or 90 years old, as an example, a brand new 30 year mortgage. And it’s because the beginning phases of the mortgage are when the efficiency is the highest. And so you always want to be on that front end of the mortgage until you truly do, if appropriate, pay the whole thing off. In other words, you don’t want to be in the middle anywhere. And it’s because of what you just said. You put yourself in a really bad position if you have equity in your home and something goes haywire. So you either want to be on the front, say five to seven, maybe 10 years of a 30 year mortgage, or you want to be completely paid off.

[05:59] And the only reason to be completely paid off in your later years, I would never do this in the earlier years, but if you’re 75, 80, 85 years old, and you want to have a completely paid off home in order to have the option to turn around and fully reverse mortgage it, then that might be an option. But I think for a lot of people, they’re probably just better not ever getting there at all. In other words, they’re better having their saved money kept separate from the equity in their home. In other words, not having the stored up wealth in the walls of their house called home equity, but instead have that money stored up elsewhere. And of course, our favorite spot are the whole life insurance policies that

[06:46] do such a good job of storing cash. But let’s keep digging in on this mortgage a little bit. Why is it that you think that people want to have their homes paid off? What drives that? Well, I think one depends on where they’re getting their financial advice. If you’re getting financial advice from certain talk show hosts, they fully believe that you shouldn’t have any debt and that you need to pay that sucker off as fast as possible. There’s also other people that just need that peace of mind, as you’ve mentioned before. But I think all of that really comes from a lack of fully understanding the future value and future opportunity of the cash that you have. Yes, I want to bring up to another example of the prepay idea that’s

[07:43] floating around quite a bit these days are to convert your mortgage into a full home equity line. Often they’re called first home equity lines of credits, where we used to think of a home equity line as a second mortgage, but these are actually in the first position. And there are a lot of people that are talking about running more of their monthly money through the home equity line, thereby somehow giving themselves some benefits in doing so. And I want to make very clear that that brings us right back to the first decision, which is where do you want to store your extra cash? And the prepayment idea is only a good idea if you’re just going to go all the way, in other words, pay off the loan entirely, but to prepay via a

[08:38] home equity line by running more money through it, because that’s really all you’re doing is putting more of your dollars through this home equity line in an effort to get that mortgage paid off in seven to 10 years, that is not our goal. We do not want our mortgages paid off. And I think a lot of times people get stuck feeling like they want their mortgage paid off because the mortgage, of course, is their largest debt. And so this big number looms in their financial environment. And I’ve even had occasional clients that are working on prepaying their mortgage while at the same time they have their mortgage, by the way, which is at 5% and the same time they have 18% credit card sitting out there.

[09:20] It’s crazy. Yeah, where the extra dollars should really be focused on the credit card debt instead of the mortgage debt, because the mortgage debt is a larger dollar, they focus on it instead of the interest rate. And it’s so important to make sure that you’re looking at interest rates when you’re doing this. And I want to also address the idea that some people have out there that they don’t want to be dealing with banks and they want to get rid of the Federal Reserve. And that’s a very philosophical thing. And so, again, we’re talking about pure financial efficiency. If you have a philosophical issue that causes you to not want to have a mortgage or debt or be involved with a bank that’s involved with the

[10:04] Federal Reserve, then that’s a completely different thought process and decision. But if you’re looking for pure financial efficiency, the, let’s just call it again, 5% mortgage for just round numbers in today’s world, that is deductible. And I want to come back to that for a minute, is still some of the most efficient debt that you can have. And I want to reiterate that this is debt that we’re choosing to have. In other words, we’re not in debt with this situation. We have debt. Being in debt would mean your 18% credit card with a, let’s call it a $30,000 balance and all you have for assets are a checking account with $10,000. That’s being in debt. Whereas if you own a home and you have debt, let’s say your home is

[10:59] $250,000 and your mortgage is $200,000, that’s having debt. And there’s a very big difference there because you’re choosing to have that debt because it’s the most efficient thing. Now, you could argue you don’t have 200,000 of cash either to pay off the mortgage, but the fact is you have a $250,000 asset that is supporting that debt. So that is a very clear distinction that we want to keep in mind. Now help me remember, what was that thing I wanted to come back to? Ooh, we were talking about financial efficiency, interest rates, and we talked about the prepayment is not, you know, about the different prepayments. I’m scratching my head trying to think the other piece. Yeah. So I’ll just start to tick off the points that we’re making here.

[11:48] So the first point that we want to make is to use other people’s money as much as often if all you’re seeking is full financial efficiency. The second point is that we want to keep money in our control and home equity is not something that we control. The third point is if we have extra dollars, we want to put those extra dollars, not against a home equity line, not as extra down payment, not definitely as extra payments, but instead in a place that we can get at it. Oh, I remember what it was. It was the tax efficiency. No, there we go. So there is some new tax law that we have put forth now in this early phase of 2018, and it’s confusing. In fact, my husband, Todd Langford of Truth Concepts, and I even got a

[12:37] little confused a couple of weeks ago when we were talking about it with some advisors and that is clarity around whether your mortgage is deductible or not. And it absolutely still is at most levels. There’s going to be some people who lose some of the deductibility of their mortgage because of the higher incomes. And yet it’s really important to understand where this loss comes from. And it’s on the top end, not the bottom end. What I mean by that is sometimes the way accountants talk about it, they feel like no matter what you do, you’ve lost some deductibility of the mortgage, but that’s on the top end. In other words, you still get to deduct some of your mortgage up to a certain level. And so we don’t want to be paying mortgages off just because we think we

[13:27] are losing some of our tax deduction. Let’s just pretend for a minute that the mortgage interest was not deductible at all and we got no tax deduction for it. It is still the most efficient or one of the most efficient loans that you can get because of where it is interest rate wise and because of the longevity of its amortization schedule. So what I mean is that 30 year time frame is going to be very, very efficient debt, very efficient use of money to have that debt, even if you don’t get to deduct it. And again, I reiterate in most cases, even the upper income earners still get to deduct portions of the interest that they pay on their mortgages. Now there might be some limitations at the state level and that’s fine.

[14:16] Clearly the federal tax is what most of us are focused on because that’s the bigger portion and the dollar figure that we can do more about. And so again, I want to reiterate that it’s important that we not throw the baby out with the bathwater, I guess, to use that saying and in terms of the deductibility of our mortgage, that we go ahead and get whatever deductibility we can. And yet even if we can’t, it’s still a very efficient loan that we do not want to prepay. You know, what a great point. Now there’s one thing that we didn’t talk about. And I think that it’s, it’s going to create an aha moment for people because typically there’s one conversation and point that’s made in all real estate conversations.

[15:00] And it’s a reason why people buy real estate because when a market’s hot or when they find a good investment, they’re always talking about the appreciation. Oh, the market’s appreciating it X percent a year, whatever that may be. And you’ll notice we didn’t even talk about appreciation in this conversation. And why is that, Kim? It is a great question because appreciation is something that we cannot control. And it’s something that we certainly don’t want to rely on as it relates to our real estate from our own home or from an investment perspective. And I’ll cover them both. So when we look at our own home, if it appreciates, which it’s nice when it does, and if it doesn’t know well, there is an appreciation

[15:51] that’s going to occur whether or not you have a mortgage on it. And I realize that people know that, but I think sometimes they get either emotionally involved with their own home, which is understandable, or they’re just not thinking clearly because the appreciation, if your community is appreciating, you’re going to get the exact same appreciation whether or not you have a mortgage on that property. So your own primary residence, if homes are going up in your area, they’re all going to go up. The fact that you don’t have any more equity in it does not cause your home to appreciate any differently than your neighbor’s home next door that has more or less of a mortgage on it. So that’s an important distinction on the personal

[16:38] resident side. And on the investment side, typically we don’t recommend that people invest for appreciation. So your focus should be cash flow. And you want to make sure that real estate investments cash flow properly. And they’re very hard to measure. You know, there’s so much information out there about real estate investing. And yet I find it’s very, very difficult to put an interest rate on it. You know, the real estate brokers want to talk about cap rates. And those are meaningful only if you’re comparing one property to another right in the same area. But it doesn’t really tell you what interest rate you’re getting on your real estate investing. And so we can use the Truth Concepts Real Estate Calculator to

[17:19] do that. And that’s available to anybody. If they’re interested in it, they can shoot us an email or just go on the Truth Concepts website and poke around on there and take a look at what’s available. The Real Estate Calculator is sold by itself, so anybody can buy it and use it and actually get a interest rate assigned to their real estate investment investing, which is separate from whatever appreciation is going on. And if appreciation occurs, that’s gravy. In fact, we typically do the Real Estate Calculator first without any appreciation, making sure that our real estate dollars that we are putting in the deal are getting us a good return, regardless of appreciation. And then, of course, you can put appreciation in there at the

[18:08] end and see what additional return you might get if appreciation happens. But it’s so important to measure your cash flowing real estate deals based on no appreciation and make sure that the interest rate that is applied to that particular deal is valid and above whatever your cost of money is and also whatever your cost of your time is. Because as we know, real estate investing takes time. And so we don’t want to be spending time and money on something that’s only going to earn us four percent. We could do that in other bridge loans and other environments without any time at all. We want to make sure if we’re doing real estate investing that it’s up there in the good high double digits so that it is worth our time and our money.

[18:58] You know, that’s really applicable. And I think that this conversation applies very much to another conversation we’ve had, which is risk equals reward. See, when you think solely about appreciation, be it living in a hot real estate market that we’ve seen in the past in Phoenix or markets like Seattle or San Francisco or wherever that may be, it’s easy to get caught in the trap of thinking that you’re missing out. It’s easy to get caught thinking, if I just buy now and hold on for a little bit, I can cash out. I think that is a complete and total myth. So making sure that there is zero appreciation when you’re factoring things through and looking at it from a cash flow perspective on investment

[19:44] properties is the way to go. Completely agree with you, Kim. Well, I, again, offer the real estate calculator if somebody is curious about it. And you can actually click it over to make it measure a personal residence as well. And if you decide that you’re interested, go to truthconcepts.com. You might look at the blog first and you can just put in the search box real estate and it’ll show you what the real estate calculator does and how it addresses both personal residence and investment property. Well, Kim, thanks for explaining some of these myths about real estate. And I hope that our listeners now see that, hey, if you got a good interest rate on your mortgage, let that thing play out. And if you don’t, well, maybe it’s time to get

[20:31] a 30 year mortgage to be leveraging things correctly or should say, putting your vision on the things that are correct and having the correct strategy. So our listeners can go to Truth Concepts to get that calculator. You can also send your specific real estate questions to Kim at hello at partnersforprosperity.com. Thanks for tuning in with us again today. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.