Mortgages: Bigger Isn’t Always Better – Episode 021

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome to another edition of the Prosperity Podcast. This is No BS Money Guy, Todd Strobel again with our resident expert and my co-host, bestselling financial author, Kim Butler. Welcome, Kim. Hello, Todd. Glad to be here today, totally looking forward to our discussion. I think we’re going to talk about mortgages from a listener request, right? Super, yes. We’ve had some questions that come up about mortgages. Of course, you know, mortgage is probably the largest debt that most people have.

[00:50] And of course, I guess there’s a lot of people that just automatically assume that the faster that they can pay off that debt, that the better off they’re going to be. And that’s not always the case, is it? Definitely not. It is interesting how that big looming principal amount really causes people to not think about it properly. I have known people to prepay a 6% mortgage and not pay their 18% credit card bill because the mortgage debt was bigger, even though the credit card bill was costing them more. So it does throw things out of whack sometimes in our view of the picture. And so we want to make sure that we get the whole truth about the mortgage out there. And it is probably one of the most misunderstood financial products, which is sad

[01:45] because, what, 70% of America owns a home. I don’t know exactly what the statistics are, but a large percentage of people either own currently or have owned homes. And it’s unfortunate to me that there’s so much misunderstanding around that mortgage. Super. Well, why don’t we kind of start at the beginning and let’s say that we’re looking to buy a home and we’re sitting down with our mortgage person and we’re trying to determine one, how much to put down and two, which mortgage is best for us? Let’s start there. What do you think? Absolutely. Great with the first two questions because the amount to put down is a big deciding factor for a lot of people. And this brings up something that we’ve chatted about before, which is that your

[02:32] own cash has a cost. And a lot of people, they do not count their cash as having a cost or you could look at it from the other side of that story, which is your own cash has some opportunity. They don’t look at their cash as having a cost or the option for opportunity. So they figure the extra 20 grand or whatever it is that they want to put down will reduce their outflow. And that’s true. It would reduce their mortgage payments. But they forget to calculate what else that cash could be doing besides building equity in a home. And so that is a critical thing that we want to take a look at. And you can run through the seven principles of prosperity, using them as an opportunity filter, as we often do in order to figure out whether you should put more cash down

[03:28] against the home as a down payment. Shall we do that real quick? Super. So I guess on one end of the spectrum, we could pay a hundred percent cash down if we were fortunate enough to be able to have that much cash. And on the other end, we could put zero percent cash down and finance the whole thing. So why don’t you kind of start with those parameters and share us some wisdom on that? Well, you’re wise to bring up the fact that we could put a hundred percent cash down because even though technically, literally most people wouldn’t be able to do that, we need to be able to analyze that if we’re going to be doing a comparison, which is going to bring up the second question, which is do you take a 15 year mortgage or

[04:12] a 30 year mortgage? Now, of course, there’s a variety of others that you could take, but those are really the two basic mortgages that are available. So going back to the amount down and just bringing up a couple of the principles of prosperity, we don’t need to cover all seven. Let’s just begin with number five, which is control. And we just need to remind ourselves that down payment money or equity in our home, which is what extra down payment money creates, is not controlled by us. And one of the principles of prosperity, of course, is keeping control on your side of the table, not giving it to the bank or the brokerage house. When you put extra money down more than is required, you are actually handing them

[05:00] the control because the thing that you’re creating called equity in your home is not controlled by you. It’s controlled by the bank or the brokerage house or the mortgage company that would lend you money against that equity. So that’s the first principle we want to take a look at. And then the other one going backwards actually is number four, which is flow. And we always want to be paying attention to our cash flow. So here you might think, well, it makes sense to put extra down because that will reduce my mortgage payment. But the problem is we’re not calculating what the extra down payment could have done for us from a cash flow perspective. So let’s just look at it this way. Let’s say you’ve got $20,000 extra and you want to put extra down and you could

[05:47] at the same time turn that $20,000 into a cash flowing investment, maybe investment real estate, maybe a bridge loan, maybe some peer-to-peer lending that you did at Prosper.com or some kind of thing that would pay you maybe even seven or eight percent per year, but paid monthly that could create cash flow in your pocket. That’s the cost of making that extra down payment. The cost is not the other side of the equation, which is it reduces your mortgage payment. The cost is what you’re giving up. It’s the opportunity of the extra down payment and what else it could have done for you, which brings us back full circle to we could put 100 percent down and there again, we have to look at that opportunity cost.

[06:35] We want to be always acknowledging that our cash has a cost and it has an opportunity. And if we put 100 percent down against our home, we have now disabled that cash from doing any other jobs. And that’s not good, efficient economic allocation, really, of our resources. Got it. So we would have no house payment, which would maybe make us sleep a little bit better at night. But if, say, a hundred thousand dollars of our money it took to pay off that house was no longer earning, maybe even, say, six percent, that would be six thousand dollars a year or five hundred dollars a month in cash flow that would not make us sleep so well at night. Correct. That’s right. And it is interesting. You know, there are definitely clients that just want to have their home

[07:31] paid off. And I say to them, if that’s that important to you and that peace of mind is being driven by that desire, then go ahead and pay it off. I’d rather have them pay it off and have the peace of mind if that’s what’s so important to them, even though it’s not the best economic decision. So we have to separate those two out and realize that sometimes peace of mind decisions for some families actually override economic decisions. But it’s our job as prosperity economic advisors to consistently guide people on the most efficient economic strategy for their money. The peace of mind thing is totally personal. Well, it’s interesting when we get back to that same peace of mind conversation, a lot of times we have unequal income earners.

[08:20] In other words, one person brings in 70 percent of the income or in some cases, 80 percent, in some cases, 100 percent of the income. And we find out that their motivation is really I don’t feel comfortable leaving my spouse with a house payment or an outstanding debt. And that’s my motivation, which we can understand that motivation. But maybe there’s a better strategy to fix that. Absolutely. And so that’s what we’re going to take a look at as we delve into the discussion more on which is the right mortgage to pick. Are we ready to shift gears or we need to cover more down payment still? No, I think we should. I think we’ve kind of decided that, you know, you should go with, first of all, saving through cash flow as much as possible, but

[09:13] making sure that you’re using that cash flow wisely and not necessarily a huge down payment is the most wise use of your funds. Now let’s look at wise ways of keeping a mortgage and being able to protect it at the same time. Absolutely. So the question typically here boils down to should I take a 15 year mortgage out or a 30 year mortgage? And what we have to take a look at again is making sure that we are having all of the economic variables be the same when we do this analysis and that we are having the time frames be the same. One of the biggest mistakes people make when they make this comparison between 15 and 30 year mortgages is they will compare a 15 year mortgage over a 15 year time frame and then a

[10:07] 30 year mortgage over a 30 year time frame. You can’t do that. You either have to compare them both over a 15 year or both over a 30 year. Now, that being said, we can also, if we don’t want to get too analytical and numerical, which and that is that 100 percent down payment, it helps us realize that the 15 year mortgage is more like the 100 percent down payment, meaning no mortgage, than the 30 years is. And so if we can acknowledge that making 100 percent down payment has an opportunity cost associated with it of that cash, let’s just say it’s a hundred thousand dollar account and it’s a hundred thousand dollar house just for ease of discussion, that hundred thousand dollars that bought that house free and clear could have over the 30

[10:55] year period of time, because remember, we’re going to analyze all things over the 30 year period of time, that hundred thousand has an opportunity cost and it could have earned money and grown over that 30 year period of time. And if you use the same interest rate where you’re making that calculation and you’re comparing it to the 15 and the 30 year calculation, you actually will see, and this is an amazing fact, that the cost of 100 percent down, the cost of a 15 year mortgage measured over 30 years and the cost of a 30 year mortgage, when all interest rates are the same, are identical. All three costs are the same. So the only difference becomes around the tax deduction and the 30 year mortgage, because you are paying more interest, has a

[11:59] higher tax deduction and consequently a lower net cost than the 15 year mortgage or the cash account. So that’s the better way to go. Minimum down and 30 year mortgage. But I think it also begs the question, which is the specific one that the listener asked us to address. What do we do with the difference? So let’s say you’ve got the ability to make a 15 year mortgage payment, which of course is going to be a higher payment than the 30 year mortgage. What do you do with the difference? You got any thoughts on that, Todd? Well, I guess one, you could set up an investment account or two, perhaps you could set up an investment account that not only was an investment account, but might also have a life insurance associated with it that could

[12:56] be used to pay off the mortgage in the event that something happened to us. Absolutely. So going back to our seven principles of prosperity, we always want to be thinking from a prosperous standpoint. What makes us feel more prosperous? A reduced mortgage, because that payment differential is going to maybe take a 30 year mortgage down to 18 or 15 years, let’s say. Does that give us more peace of mind, more ability to think from a prosperous standpoint, or does having a cash account that’s liquid and totally ready for our use if needed, does that give us more peace of mind and thinking from a prosperity standpoint? So that’s the think principle. Then of course we have see, we want to see everything

[13:42] from the big picture. What’s more important to your family? Having a paid off home or having cash that you can live on, make transitions with, move if necessary, et cetera, et cetera. So that’s think. Then we have see. Next we have measure. Are we measuring the opportunity costs? We’ve already talked about that. Flow, cash flow. We want to have cash flow that is not only making us save money, but also in having that money invested in such a way that it’s flowing money back to us. And you cannot make your own primary residents flow money back to you. I suppose you could, if you ran in and out of room or something like that, and there’s certainly homes that that’s available. But for the most part, if we have extra dollars, we

[14:32] want to put those extra dollars in a place where the potential is there for money to flow back to us. And as you mentioned on the life insurance, if you use that for your extra money, you could actually instruct the dividends to be sent to you every year, or you could borrow against it and go buy investment real estate, or you could just have it sit there as your peace of mind slash opportunity account to go forward with and having that prosperous mindset that we talked about in principle number one. So that’s flow. Then next we have control, which we’ve already talked about. You’re going to have more control if the quote equity of your home is in a liquid account that you can get to rather than having it

[15:14] tied up in a physical piece of property that only the bank can give you access to. And then we have move and multiply principles number six and seven. If you’re putting extra money into your home, that’s not movable unless you’re going to move or the bank is going to give you a second mortgage, but neither one of those are in your control. I guess whether or not you want to move is, but nobody wants to move to have to access their account be much better in a life insurance policy cash value, or you could get it at any time. And then seventh is multiply where you have the ability to have dollars do lots of jobs, which is what you referenced. Let’s get the death benefit. Let’s get the tax advantage.

[15:55] Let’s get the dividends that the life insurance gives us in addition to the home and the roof over our heads and the place to have the kids and all of that. Let’s do both. We want to have both. We want to have the liquidity and to have the house. And then lastly, as you also mentioned, you could use the growing cash value of the policy to pay off the mortgage way down the road. But most clients, once they really get all of the aspects of the mortgage and they understand the efficiency of keeping their dollars stored elsewhere, realize that the best mortgage is minimum down as long as you possibly can, like a 30 year mortgage for as long as you can in your life, literally meaning that when you’re in

[16:46] your seventies and eighties and nineties, you still have a mortgage payment because you have used your other extra money to create resources, which create the cash flow to make that mortgage payment with that is the most efficient environment. So if you’re making the decision today, have a minimum down 30 year mortgage, do not make any extra principal payments, put any extra money that you can into cash value of life insurance, typically whole life is best. And then if you’re in the middle of a mortgage somewhere and you want to refinance refinance that debt, but over a 30 year period, don’t get sucked into the 15 year mortgage being the better deal. Got it. So cash flow above all else with a

[17:32] way to accumulate the savings in the vehicle that we choose to use, to accumulate that savings is a whole life insurance because you have a right now, a four and a half to five percent savings account in addition to a death benefit that could be used in the catastrophic event that something happens to you. Correct? You got it. Super. Well, I think that pretty well sums up everything for today. Again, I must apologize. We have definitely had some audio issues on today’s show, but hopefully our techs are going to be able to clean those up. Again, this is No BS Money Guide Todd Strobel for the Prosperity Podcast. Thanks again so much, Kim Butler. Thank you. Thank you for listening to the Prosperity Podcast.

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