Ep. 92: Should You Pay Off Your Mortgage?

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On today's podcast I'm going to be talking about should you pay off your mortgage? When I was in college I co hosted a radio show with a few others and it was myself a real estate investor. It was a mortgage broker, it was also a financial advisor and we talked about things of different financial matters and one of them that came up that weekend was should you have a 15 year mortgage or should you have a 30 year mortgage? Now, before I talk about this, check out the associated blog post that's with this podcast. It talks about a couple different topics and it links to things like why buying is more expensive than running. Also it talks about us in our personal situation and what it looked like for us buying 10 years ago in the hottest market in Asheville.

And I talk about some of the.

Returns that you get there. So again, a lot of people think that buying a home is an investment. I really want you to think carefully.

Before you make this assumption.

Buying a home is an emotional purchase.

Now let me be clear.

I've owned multiple residences.

We are currently in our second home.

My wife and I just finished building a wonderful home for our family here in Asheville, North Carolina. But let me be clear, there are definitely better financial options than going and buying or building your own home. And I would call building your own home something akin to sticking a knife.

In your stomach and watching the dollars bleed out all over the place for a couple years.

So again, I love owning my own home. I had a wonderful experience doing it. But you really have to consider buying or building a home for yourself or your family more of an emotional decision. It is certainly a financial decision as well though. So if you do decide that you want to buy your own house or even an investment property, let's talk about how you can optimize the financing. Now on the commercial side of things, we employ everything from shorter term variable rate products all the way up to fixed rate amortizing 10 year loans. And it depends on the specific project.

It's depends on the specific length of the project.

So if you own a house and you plan to live there for let's say, 10 or 20 years, maybe a.

Longer term loan makes sense for you. The average person lives in a house for five to 10 years. I think the data shows about seven years. So logically you should have a loan that lines up with that. Now why would you want to have a 15 year mortgage? So the financial advisor on that show is mentioned three things. One, you would pay off your debt faster. That means you would own your home sooner. A corollary to that is you have faster equity growth. So it's like forced savings. A bigger portion of each of your monthly payments goes towards your principal. So you're paying down principal faster. You also get a lower interest rate.

So not only are you paying down.

Your principal faster and are you paying less interest, but you also have a lower interest rate when you have a shorter term loan. So, so this is really valuable if you think about it. You're paying less interest overall. And that's what people will show you. They'll say, hey look, you pay, you know, half the interest with a 15 year loan than a 30 year loan. I would also be careful. You can also look at say a 7, 1 arm. You could look at a fixed 7 year mortgage with an adjustable rate option after that. That's going to give you a lot of these same characteristics. And look, these are all valid points.

So I want to make sure you.

Understand that getting a lower interest rate is valuable. Paying down debt faster is valuable and faster equity growth is valuable as well. But I also want to talk about the reasons why I think you should do a 30 year mortgage or even potentially an interest only mortgage. And I'm going to dive deeper into this. All right, so point number one, lower payments. So let's say you have a $400,000 mortgage at 4% interest over 30 years versus 15 years. Your payment on a 30 year mortgage in that case is going to be a little bit over $1,900, okay, around about $1,910. Conversely, your payment for a 15 year mortgage is going to be $2,960. That's more than $1,000 a month difference. Even if you're paying a slightly lower interest rate with that 15 year mortgage, your payment is going to still be significantly higher. In this case, it's about 50% higher. Okay, so you're going to be paying more per month. That means there's less in your bank account at the end of the month, less to spend on. Okay, but you are building your equity faster. As we mentioned before, however, this is kind of a dirty secret of investing in real estate. Your equity earns. Drumroll. 0%. So when you build equity in a property, I talk about this in my book. I've talked about this on multiple podcasts. The first property we bought was an investment was about $100,000 property. I was making approximately, let's say, $3,000 a year on that property. And let's say I put 10% down. I'm trying to use easy numbers here. These aren't the actual numbers. My actual numbers were actually a little bit better. But let's say I put 10% down and I earning $3,000 a year. $10,000. $3,000 a year. That's a 30% return. Well, over several years my income grew, so I was getting 6,000 or $7,000 a year, but my equity also grew. So even though my income doubled, my equity went up by about 10x. So I had about $100,000 of equity in that property. $6,000 on $100,000 of equity is only $6 thousand. So even though the property almost doubled in value and my income doubled in value, my return went from 30% to under 7%. And that's because you're equity in a property, you're losing leverage and you're not earning any money. So if you're paying down your mortgage and your interest rate is 4%, you could say, well, Kris, I'm earning 4%, I'm getting 4% of my money. Well, first off, if you have no other options for your money, it's good to pay down debt. However, if you have other options to invest at a higher rate than 4%, and that doesn't even take into account the tax advantages. So your actual rate may be, say, 3% or even lower than that. You have the ability to borrow or reinvest that money at a higher rate. So that's something you need to consider as well. Do you have other investment options out there? I've always had the ability to invest at a higher rate than the mortgage rates that were out there. And that's one of the reasons that I think you should really have a longer term mortgage. I want to have that money going.

The third point I want to make.

Is that you don't actually own your home. Even if your home is fully paid off right up until that point, the bank can take your home from you. They can foreclose on that property. So let's say you and I both own that $400,000 property and I have a mortgage where I only put 10% down. So I have say 40% or $40,000 or $50,000 of equity in that property. You paid cash. We both get into trouble. We don't pay our taxes for some reason. Maybe I don't pay my mortgage or taxes. Or maybe you have a small mortgage. Maybe you owe, let's say you owe 50% on that property of $200,000 of equity versus my 40 or $50,000. In both these examples, you can lose your home. So the bank, if you owe 50%, will say, hey, I'll take your home from you.

I can sell it at a fire.

Sale price of $300,000. Even though it's worth $400,000. We'll recoup our $200,000 plus $100,000 of profit if they foreclosed on my property where I had only $50,000 of equity and owed $350,000. If they fire sale it at $300,000, the bank is still going to be out $50,000. They're more likely to work with me to restructure the payments. And I know this because I used to restructure non performing loans and that's exactly what we would do. We didn't want to take the property back. We wanted to have the owner pay us what we were owed so we would restructure those loans for those people. So in a lot of cases, you're actually more likely to lose your amount of equity if you don't pay your taxes. The same thing. The government can put a lien on your property. They can do that. So you may own your property, but in very few cases do you actually fully own your property, even if you have no debt on your home. So These are the three points. So again, the reasons you would want a 15 year mortgage, pay off your debt faster, you get a lower interest rate, pay lower overall interest over the course of the loan and you have faster equity growth. It's like forced savings. The reasons to get a 30 year mortgage would be one, lower payments, number two, your equity earns zero. So you can put that money elsewhere, you can invest it elsewhere to get a higher rate of return. And number three, you don't actually own your home anyway, so you might as well have the mortgage on there and get the benefits of having that. So given my argument, if you were going to pay instead of around about $2,000 a month for a 30 year loan, you're going to pay $3,000 a month for a 15 year loan. That extra thousand dollars, what could you do with that? Well, I would say take that $1,000 and invest it at 15% over 15 years. In that case, you're going to have almost $670,000. With $670,000, you could pay off the remaining amount on your 30 year loan, which would be around $260,000 at that point in time and you'd have enough money to buy a whole nother $400,000 house.

Of course you could say, well, Chris, that's silly. The house, you know, it's going to.

Be worth More than $400,000 at that point. You know, buying a $400,000 house, regardless, you'd have enough money left over to buy another property if you wanted to. But there's a bigger point. Let's say we go back to that same scenario. You have a 15 year mortgage, I have a 30 year mortgage. We own our homes for five years. Five years down the road, we both lose our jobs, we get into financial trouble.

Well, if I'd been taking that $1,000.

And reinvesting it, I'd have almost $90,000 in the bank. Okay, almost $90,000. That's going to be able to pay my mortgage for almost 404 years. So I'm going to have a bigger work chest to take that money and pay expenses. And if I'm in financial trouble, that's going to be very helpful.

Personally, what I would say is, okay.

Don'T assume you can invest it at 15%. Be even more conservative. What I would say is put it in a high cash value life insurance policy. That's what we do. We put our excess cash into our cash value life insurance policies. That means you're going to be able to earn a healthy return. It's also going to provide protection for your family. So if something did happen to you, you're going to be able to pay off your house and hopefully that additional insurance would be able to take care of your family. That's certainly what happened in my family's circumstance. When my father died when I was five years old, his life insurance was enough to provide a cushion for my sister. Myself and my mother gave us a little bit of money to help kickstart our college education and do that. So again, I'd love to hear from you. What do you think? If you have a property, should you get a 30 year mortgage? Should you get a 15 year mortgage? Should you get something else? Should you get an adjustable rate mortgage? And what would you do with the money if you didn't pay down the mortgage for your home? Let me know. Put it in the comments below. Reach out to me@chrisxtlevelincome.com Hope you enjoyed the show today.

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