#54: Is a Mortgage a Great Way to Force Savings?

Foreign. Welcome to the Passive Income MD podcast where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hi everyone. Hope you've had a great week this week. Mortgages have been on my mind. I just closed on my current home and my loan for my new home was just approved. So definitely mortgages have been on the mind. It's an interesting time with interest rates and savings and we can talk about strategies a little bit later. But one of the topics I wanted to think about right now and talk about was, is a mortgage a great way to force savings? So now there are people who think that mortgages are a bad thing. There are people that think mortgages are a great thing. Again, I think it depends on your interest rate, where you're at and these kind of things. But it's funny because I began thinking about this topic back when my father first retired from practice. Now he had a 40 year career as a physician, he was a surgeon. And I, you know, trying to be the good son, definitely try to help him. And as he prepared for the transition into retirement and luckily I knew a few things, I'd read some great blogs, I learned a lot on my own and I was able to figure out, you know, where his current resources were and what he needed for the future to live comfortably. Now when I started looking into everything that he had and, you know, everything he had saved up, where his assets were, the thing was that he was like any typical physician, probably like many physicians that might be listening to this, where you were before you started getting into finances. I mean, nobody teaches you this stuff. You know, you don't know what to do. Your focus is on helping people. Your focus is on building your practice, being the best physician you can be. But you're not so concerned about the other side, the finances, in terms of where to utilize your resources and how to set yourself up. And so what happens to a lot of physicians that I found is that they get to the later years of their career and realized, oh, if I stop working, I'm not exactly sure if I have enough to retire. I'm not sure if I have enough to live comfortably. Where will the cash flow come from? You know, my father, he had scraped some things together in terms of like the information from his friends, maybe some accountants and that sort of thing. But unfortunately he didn't end up planning that well, for his own retirement. Now, the one silver lining in all of this is that the home that we grew up in, we had lived in that home for many, many years. And he had lived in that home. It had long been paid off. That mortgage had been paid off. And the cash from that sale which he ended up selling, it ended up being more than the amount that he had in all of his investment accounts combined. To me, that was kind of interesting to find out. But it had me thinking about whether, you know, the mortgage was a great forced savings or not. I mean, to be honest with you, all I kept thinking was after we sold that home, I kept thinking, oh my gosh, I am so glad that he had paid off that house, that he had a mortgage and it actually forced him to save. And I know that many people think that mortgages are a terrible thing. I mean, no one likes making that monthly payment. But I think that having that mortgage, it really helped him from a savings standpoint. I mean, let's talk about it. Number one, it was easy. I mean, I think that many experts suggest any sort of like a 10% savings rate. Right? You've heard of that. The white coat investor often talks about saving 20%. The thing is, you know, due to life's many expenses, things come and go. I mean, many of us kind of fail to put that money aside. I mean, we don't put that money aside first and then spend the rest. Oftentimes we spend and whatever's left over, we try to save. Right, but how many people actually forget to pay the mortgage? I would venture to say very few people actually forget to pay the mortgage. It comes every month. Most of us, it's probably automatic off the top. And it's one of the first things we worry about when the choice is whether to not pay the mortgage and foreclose or to pay it on time. I think most of us are going to make that a priority. And so the good thing is a little bit of your money towards that equity is saved every single month. Number two, it actually is known to create long term wealth. I mean, I don't know about you, but I've read the statistics and it says that the average homeowner has a much higher net worth than a renter. And this was done by the US Census Bureau. I mean, they put out some statistics from now and here. And then last time that I saw it was back in like 2013. They said that homeowners at that time had a median net worth of about $200,000 versus about $2,000 for renters, that's a huge difference. That's a, I would say, 90 to 100x difference. Now, why is that? I mean, this could be like a chicken or egg situation. Is it that homeownership leads to higher net worth, or is it just that higher net worth? People buy homes. I mean, to me, I think it's a little bit of both. I mean, homeowners are typically a little older. They make higher salaries than younger renters with lower salaries. But on the other side, over time, people's properties, you know, if they own it, appreciates over time. I mean, supposed to be in line with inflation, people might say, on average, somewhere between 3 and 4% that home appreciates. So you're gaining equity as you go on, just by sitting on that home. And then most homeowners end up using leverage, right? You might have put down 20%, 25% on your home. And what happens is when that property appreciates 3 to 4%, you're not just making 3 to 4% on the home, you're making 3 to 4% on what you put down. And you only might have put down 20%, but you get 3 to 4% of that full appreciation. And that helps you actually increase your net worth quite a bit over time. I mean, I can give an example of that. You know, let's say you bought a $500,000 home, and again, where I live in Californ, 500,000 home. I mean, unfortunately, it doesn't get you that much. But someone else listening to this, it might get you quite a bit. It's just kind of the way things are. But let's say that appreciates that 4% a year, then actually you gained about $20,000 a year off that $500,000 home. However, if you had only put down 20% for that home, about $100,000, your actual return on investment quote, unquote, is not just 4%, it's actually 20%. Because on that $100,000 down, you. You actually made $20,000. And that's one of the benefits of appreciation and using leverage. This is usually, you know, we usually talk about this when it comes to rental properties. But even for your own home and your own net worth, you can see how this can multiply your gains over time. Now, there's a really simple explanation. I didn't talk about taxes, fees, and that sort of thing, but it just gets you thinking about how leverage can multiply those returns. Another thing, tax deductions, you know, interest on your mortgage, it can be deducted and you all know that you all look for that, that's probably your biggest deduction. There have been some new tax plans over time where the benefit has been reduced for some people, especially in high cost living areas. I know, I've definitely felt that living in California where average homes easily well into the million dollars. And so mortgage interest, there's a cap on it now where the amount that you can actually deduct on your mortgage interest, unfortunately it's there, the cap, it may change over time, but at least you're still able to duck quite a bit. And that's kind of a nice benefit. And then there is that benefit of when you sell your home and you have some gains on it, you might not have to pay capital gains on it. For example, if you lived in your home two out of the last five years, when you go to sell your home as a single person, you up the first $250,000 in gains. You don't pay taxes on it, it's totally tax free. If you're a couple, it's $500,000. So for someone who's able to do a little bit of arbitrage, meaning that you maybe buy your home, you live in it, it increases in value and you go to sell that home, you still have buy something else, right? Let's say you buy something else in a different state or in a lower cost living area, or you downsize, you could take a lot of the gains that you got on that home and it's completely tax free and you roll that into your next home and that's a huge benefit. As you all know, we all are in very, very high tax brackets too. So to have $250,000 or $500,000 in tax free gains, I mean that's a huge deal. Now, nothing's perfect. And you know, the mortgage itself, it may not be a great savings vehicle. There might be some cons to it. I've already talked about a lot of the pros. But let me tell you about some of the reasons it might not be great as a savings vehicle. There could be other better places to invest your money, as you know. You know, if you've read any of the books like Rich Dad, Poor dad, all these things, your home, when it comes down to it, it's truly not an investment. It is more of a liability of sort of cause you live in it, it doesn't produce income per se. So many would say that it would be better to put your money elsewhere to actually save and invest. And I think there's A lot of truth to that. But again, this is assuming that you've just been paying this thing slowly over time, but knowing that also people, again, are not the greatest savers and investors. Like I said, the mortgage is a great way to force that. Now, the other problem and the reason why it may not be a great place to save money in, is the liquidity issue. Now, for those who aren't familiar with that term, when it comes to being your funds, being liquid, it means that you can tap into it quickly if needed, meaning that you can convert it to cash. For example, like an emergency fund you have in a savings account that's extremely liquid. Some of your stocks might be very liquid because you could just sell that. Now, having your own home, it's not something that you could just easily sell and then take the cash, but you also need a place to live. Now, the one way to mitigate this or to kind of address this is to have something called a home equity line of credit. It's called a heloc. In other words, it's almost like a second mortgage that sits on your home that you can tap into if you need it. Now, it just sits there as like an open line of credit. And I've used that before. I've had that on my previous home and when I needed a little bit of cash to maybe go into an investment and I knew that their opportunity was there and I needed that liquid capital. I knew the money was coming in otherwise through work and business and. And I needed a little bit extra. I've tapped into that heloc. It's also, I've said about it, I use it as an emergency fund of sort in case I needed that cash. But if you don't need it, it just sits there. And to me, it was well worth just having it there. I think it was like $75 a year just to have that HELOC just in case I needed to tap it. You just don't want to use that HELOC as like a reason to spend more on your house or buy a nice car depreciating asset. I just always had it just in case, and it just allowed my investment or my savings in my own home to be a little bit more liquid. So in any case, I mean, what do you think? I mean, do you think that a mortgage is a great forced savings vehicle based on what I've talked to you about? I mean, again, it might not be ideal for everyone. I mean, for people that are a little bit more savvy, you know, they'd rather have a little bit less in their house and more in other investments. But for others who may not, you know, be. Be super mindful of, you know, savings and investments. You know, for someone like my father who was just focused on being the best physician he could be and that's just an amazing thing, the mortgage actually ended up saving him. I mean we took the proceeds from the sale of that home. He was able to purchase a actually it was three rental properties. And you know, with his along with his retirement accounts, the cash flow from all that was plenty enough to to live in retirement. And so we were luckily able to to position that and that served him extremely well. And so in that case, I think it's a great for savings vehicle. Now I'm just wondering what it is for you and how you think about it. I think we'll talk about that later in terms of different strategies with your mortgages. Anyways, hope you got some value from this. Hope you have a great week and we'll talk again next time. See ya. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. 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