E5: Make Money like a Bank – The Top Mortgage Myths

Holly: Today we are going to discuss mortgage myths and how you can start sticking it to the IRS. This is Nate, and he makes sense out of money.

Nate: She’s Holly, and she helps people find financial freedom. This is Dollars and Nonsense. If you follow the herd, you will get slaughtered.

Holly: One of the biggest myths today is the fact that you should refinance. We hear all the time, “What is the interest rate?” [If] the interest rate has dropped, you need to refinance. The lower the interest rate the better it is for you. What do you think about that, Nate?

Nate: Yeah, one thing we have to always understand is [that] the bank, they’re selling to you. We don’t think about that too often. They love to churn your business. And, of course, they want to entice you to come back in and pay the mortgage fees and the closing fees, just to be able to get another mortgage out. I don’t know, Holly, normally, what is it—the average person refinances their mortgage once every five years.

Holly: Once every five years. Absolutely.

Nate: Yeah, something like that. It’s all the time. And that is one of the biggest mortgage myths is to always go for the lower interest rate. And the cheaper the interest rate the better off you’ll be. But we find that’s not always the case. In fact, one of the ways they entice people to get a lower interest rate is by offering them a lower interest rate on a fifteen-year mortgage instead of a thirty. I guess that’s one of my thoughts: the difference between a fifteen-year and a thirty. And why is it that the banks offer a lower interest rate on a fifteen-year mortgage than they do on a thirty?

Holly: Well, Nate, actually what most people don’t realize is they’re actually going to be giving the bank more money in the fifteen years than they will if they kept the thirty-year mortgage. And part of the reason is every time we refinance we restart the process of paying down the principal and paying down the interest. And we really pay an interest rate over the entire period of time. So if you get a lower interest rate for fifteen years, you’re paying higher interest initially in the first several years than you are at the end. And because you’re paying additionally higher rates, up to 70, 80, 90%, in the beginning you actually are going to start giving the bank more money than if you kept that thirty-year mortgage for the entire length of time.

Nate: Right. And one of the biggest things that people don’t really realize, and it’s something that’s really dawned on me, the reason that the banks give you a better rate for a fifteen-year mortgage is because that fifteen-year mortgage is less risky for the bank than a thirty-year mortgage. A lot of times, they’re trying to promote these fifteen-year mortgages, and they’ll say “Hey look! In this fifteen- year mortgage, you’ll get out of debt in fifteen years and you won’t have to pay as us much interest because you only got fifteen years instead of thirty on the mortgage. But one of the biggest keys is really the only difference [between] a fifteen-year mortgage and a thirty-year mortgage is how much you’re sending to the principal. And as you know, Holly, in other words, a fifteen-year mortgage– you might have to pay $2000 a month, whereas a thirty-year mortgage you’re only paying $1200 a month or something like that. Really you’re just stuffing money into the principal of the house. And it’s one of the biggest issues. And that’s what we were talking about with the IRS. Because one of the biggest things is that as you are stuffing money into the principal of your house, that’s actually using after-tax dollars. Whereas we know with the interest that you pay on a mortgage we get a tax deduction for that. So I’m going to try to find every way that I can to try to reduce my taxes. And you can actually reduce your taxes drastically by going the thirty-year route instead of the fifteen-year route.

Holly: And, Nate, that’s really key here is the fact that the money going principal does not help in your taxes at all. So the bank doesn’t mind if you’re paying them more money in principal because it’s giving them more dollars to use and loan out. Versus if you’d kept that thirty-year mortgage you’re actually deducting more interest because you have at least seven years where you’re paying 80% interest. And that interest is deductible for taxes. But if you refinance the fifteen years, you’re losing that tax deduction and a significant amount of deduction—we’re not talking a couple of dollars here, we’re talking about hundreds to thousands of dollars you could be losing just by refinancing the mortgage from a thirty-year from a fifteen-year mortgage.

Nate: Even Warren Buffett says that a thirty-year mortgage is one of the average American’s best plays that they can make on the dollar. You’re locking in at a 4% rate these days a lot of the time, with a thirty-year mortgage, a tax deductible 4% rate and for thirty years. At thirty years the dollars that you’re paying to the bank are not the same dollars that you were paying them at year one. Due to inflation, they’re worth a lot less. Honestly, it actually puts the bank in a worst position giving you a loan over thirty years; it puts you in a better position because you have more control over your money early on because you’re not sending it all to the bank.

Holly: And, Nate, just think about the housing prices in a fifteen-year period. What has happened to housing in fifteen years? And more often than not, you’ve given them all this money, and you have a house that is depreciating over time, but if you’d done it over thirty years, you’d given them weaker dollars every year you went on and you were able to deduct more for your taxes. And that’s the key here. Why do you want to refinance something when you’re going to be just giving more money, principal, to the bank? Basically, it’s like making a payment or making an investment in something that’s earning you zero percent return on your money, that’s after-tax dollars, that’s making you pay more taxes.

Nate: I think our listeners would love to understand that as well. How is paying money into the principal of your house giving you a zero percent rate of return?

Holly: Well, it’s quite simple in the fact of you’re using your after-tax dollars, money that you’ve earned, you’re putting it down to pay the principal. So no money, that’s not an investable interest, your house is depreciating, but when you give money over to just the principal only, you make that extra house payment, it has zero rate of return on your money; you’re getting nothing for that money in return.

Nate: The house doesn’t actually write you a check for sending them that money. It’s not earning you a return. The principal doesn’t change. We’re putting money into an asset that can’t actually produce a profit for us. The banks want us to stuff as much money in there as we can because then they can go use it again. And the quicker we give it back to them, the happier they are. I totally agree with that. And maybe a listener has a question regarding that, and maybe a side of things where of course house prices do go up over time, but whether or not you have a mortgage on your house or you own it free and clear because you made so many extra principal payments, it doesn’t determine the price of the house. You can still have your house appreciate even when there’s a mortgage on it. The principal just doesn’t change. The value of the house may change, but you’d get that whether or not you’d have the thing paid off or mortgage to the hill.

Holly: And basically those extra payments are making you cash poor and asset rich. You can’t do anything with that asset. Unless you go and sell it.

Nate: And that’s huge. That whole cash poor issue that so many people are stuffing a lot of money in … you listen to people who listen to Dave Ramsey or Suze Orman– a lot of them are proponents of the fifteen-year mortgage or even quicker. Dave Ramsey says go out and make extra payments on your fifteen-year mortgage and get this thing paid off in five years or ten years. And really at the end of the day you have your house, but you don’t have any money. And you’ve got nothing working for you. You might have a $200,000/300,000/400,000 house, paid off, but that’s not going to write you a check when you want to retire. That’s not going to produce profits for you. One of the biggest things … so instead of going that fifteen-year round or that extra payment round, it would be best to not send that money to the bank but to go use those extra dollars that you would have normally sent and go do something else with it. Or that’s what I would rather do.

Holly: Well, Nate, you really want to put it into something that’s creating an investment for you with a return on your money. And most of the time you want a guaranteed return on that money. And that extra payment, the bank loves it, because it gives them more dollars, but the IRS even loves that extra principal payment because as long as you’re paying that payment to principal then you’re increasing your taxes, because only the interest is deductible. And that’s really key there: is take those extra payments and to put it into an investment that’s going to yield you a profit or a return.

Nate: And it’s not very difficult to find something that’s going to produce you a higher return than what you’re paying in interest on your mortgage. We’re finding people with mortgages even at a thirty-year mortgage at 4% and less. And essentially if you’re wanting to make extra payments or refinance to a thirty-year mortgage, you’re essentially saying you don’t know of any place that can make 4%, but as we said, that’s a pre-tax number; in fact, you get to write that off, so really we’re talking about 2.5% or 3% after tax. And you’re saying you can’t go make that anywhere? That’s one of the keys… stop investing money in the equity of your house. It’s one of the worst—it is the worst investment– you can make because it’s guaranteed to grow by zero percent. And use after-tax dollars to get it. Instead take those principal dollars—I’ll tell you just with me, Holly, I don’t know about you, but I actually have an interest-only mortgage; I’m only paying interest. Which means 100% of my payment goes as a write-off on my taxes. And I get to keep all the dollars that I would have normally sent to the bank and principal, and I actually get to work with that and invest with that myself. And I know I’m going to make a higher return than what I have to pay to the bank.

Holly: Well, Nate, you’re definitely making your house your biggest asset. You’re definitely leveraging it to make it a maximum return for you. Now what did you do with your investment?

Nate: That’s a great question, and if our listeners don’t know our principles, I don’t think it’s even too wise– and, Holly, maybe there’s other people out there who would disagree—to go out and take the money that you would have normally sent to principal and throw it into something that’s volatile. In other words, it wouldn’t be too wise to go out and take the thirty-year mortgage and all those dollars that you would have sent on a fifteen-year to go make that investment elsewhere that could go belly-up. Because you could be stuck with a mortgage and all the money that you thought you were going to be saving could [disappear]. So I want to go try to find the best place to put it without having to take a lot of risk, and the best place I’ve found to do that is inside of a participating whole life insurance policy. And so those are guaranteed to grow every single year, so I know that I’m going to be making money on this deal. And it’s actually tax-free. So the IRS is supplementing me here by giving me a tax break on all the interest I’m paying; I can write 100% of it off with an interest-only mortgage. And now with all those principal dollars that I normally would have sent to a bank in a fifteen-year, thirty-year mortgage, I’m now putting into a policy that’s growing tax-free, that I can access at any point. And really what I’ve done is I’ve been able to design this system to where I’ll have as much money in that policy in fifteen years to where I could walk over to the bank and pay them off, without even having to change my cashflow. In other words, if I would have done a fifteen-year mortgage, I’d have the mortgage off the books in fifteen years, or if I would have done this interest-only mortgage and saved my principal elsewhere then I could still pay them off in fifteen years or less. But the key is, I have control now. So let’s say–we know this happens– if I had went the fifteen-year route, let’s just talk hypothetically, if I went the fifteen-year route, and seven or eight years comes by, and I’ve really spent a ton of money sending back to the principal of my house, and I hit a financial bind, income goes way down, I get sick. Something happens to where I can’t work, I can’t earn money, I don’t know what it would be, and now I’m coming back to the bank and saying, “Hey, I’ve given you guys all this money for the past eight years, but I’m broke now; I gave you all the money I needed, and now I’m having a tough time. Can I go refinance my house?” What do you think they’re going to say?

Holly: They’re going to tell you no because they cannot show how you can repay a loan. And even if you have an asset that’s substantially significant, say it’s a building you might own or something that would more than cover the cost or collateral for that loan, if you cannot show that you can repay a second mortgage, they’re not going to let you refinance that house. They’re not going to let you borrow more money because you can’t show that you can pay the money back now. And it’s really sad because what you have done is exactly what we’ve talked about. You have created a system that has allowed you to be asset rich and cash poor. You don’t have any more dollars, and most of the time people are hopeless then. And they end up having to sell their house or downsize or do something significant like that because they listened to what everyone else told them to do. Which was make an extra payment …

Nate: Get it off the books as soon as possible.

Holly: Get out of debt. You have to get out of debt. You need the bank out of your pocket and the only way to do that is to keep making those extra payments. And it’s really sad because we’ve created a society where individuals don’t own their houses and they don’t have any cash and then something catastrophic happens. Now I want to bring back to point something that Nate said about participating in a whole life insurance policy. Nate, let’s say that something had happened to you, though, in that time, and for some reason you graduated from this earth, what is the other side of the benefit of having that whole life policy?

Nate: Right. So even if I didn’t make it the full fifteen years and something was to happen to me, my family will have five-times what the house would be worth in a death benefit. So they could pay off the mortgage and then have some. Instead, if I would have gone the other route, as you said Holly, and just started sending all the money– I am sending it to my policy and I send that to the mortgage company — well then if I were to pass away, then they would be stuck with the mortgage and nothing to pay it off with.

Holly: And is that death benefit tax-free? N: Yeah, it’s tax-free. So, Nate, actually by doing an interest-only mortgage and taking those principal dollars and putting it into a participating whole life insurance policy, he has actually created security for him and his family, not just today but in the future as well. So if something did happen to him, his family isn’t stuck with the mortgage, and if something doesn’t happen to him and he goes that seven, eight years, even fifteen years, he has the money inside a policy to be able to go and pay the bank off. And he’s not cash poor anymore. Because we all need dollars today. We need cash to live on day in and day out.

Nate: And that’s the thing. People don’t understand that when you do a fifteen-year mortgage, you’re actually giving the bank more control of your life. Because you’re obligated to send them such a large payment. And if you can’t send it to them because something happens to you financial, guess what, they’re not going to just let you walk in and refinance to a thirty-year to give you some breathing room in your payments. They’re going to say “No, you’re not credit-worthy right now. We’re not going to refinance it.” And then, guess what, you’re foreclosing on your house at that point. And that’s terrifying. So what I find is key is the more equity you send to the bank, the better position you put the bank in, but it actually puts you in a worse position. Because now you don’t have those dollars anymore, the bank does. And to get those back you have got to get approved by the bank. So what I like to call it, Holly, is just separating the equity from your house. Don’t send the equity to your house or to the banker, put it some place else where you can actually use [it] and actually produces profits. And the key would be that’s why we use a policy because I don’t want to risk that money, I want it to be there. And so that’s why I use the policy as my tool for sure.

Holly: Another point we want to bring up is what are different ways you can actually use your house as an advantage with the IRS. There are several different possibilities and there’s great ways to interact and do that, but one of the most important ways is for us as individuals and people that own houses and have mortgages understand that we take all the tax benefits and breaks we can when we have to pay taxes to the IRS. And our mortgage or our house is one of the biggest assets we can use to reduce our taxes in regards to the IRS. Nate, do you have a suggestion?

Nate: Yeah, the one we definitely already talked about, which is the obvious one, is your interest reduction. And we want to keep that going as long as we can, but on top of that we also have, and especially this mainly works for those in business, Holly …

Holly: Small businesses.

Nate: Yeah, small businesses as far as being able to rent your house to your business. And if you aren’t aware of how to do that and you’re a business-owner, you really ought to get the knowledge. Because the IRS actually allows you to rent your house, your personal residence, for fourteen days a year and all the rental income that comes in for those… you can get it without having to claim it as rental income. And so one of the best ways to do it is to have your business rent your house to do an event or have a board meeting or to do something like that. So just have your business rent your house for various purposes. A lot of times people do it for board meetings, they have a monthly board meeting at their home, instead of at the office or some place else. And you can actually rent your house to your business for fourteen days a year for just using the average cost of what it would take to rent a facility at the square footage of your house. Regardless, I don’t want to get too much into the weeds, but essentially you can get fourteen days a year of tax-free rent personally but actually get to write it off as a business as rent expense. And so you can actually take a big tax write-off by renting your house to your business for fourteen days during a year. That’s the max you can do it. And get a big tax-break from doing that. And that’s just a cherry on the top. And I guess you could call it a side benefit for this mortgage discussion because the main one that everyone is already taking advantage of: How can we keep this interest reduction on and get as much as we can so we can write-off quite a bit from our taxes and get some tax-breaks for the rest of our life. That’s why I’m doing interest-only because I want 100% of my payment to be written off of the books. But also renting the house is another advantage. Did you have any others in mind? Or was that kind of the main idea? Or I guess you can do the home office, as well. I know you worked from home a lot of the time, Holly, which means you have a home office. And that can even do it, with being able to write-off expenses because of your home office if you’re in business.

Holly: You can actually take, even with the business-side of things, for tax
purposes .. I actually do have a whole office in my house that even has an outside door entrance into my office so people can come, so they actually don’t even go to the main residence. Because of that I charge rent every month. The business pays me rent in regards to this office space because it is strictly used for office. There are a lot of different ways you can use your house that is an asset to get tax deductions from the IRS. And if you don’t know how to do that, you really need to be asking an accountant what is the best way to take advantage and leverage my house, in regards to this being an asset, to be able to make the biggest tax deductions I can with the IRS.

Nate: We keep calling our house an asset, and it is an asset, but unless you start using the equity you’ve got, using the leverage you can have, using the deductions you can get, it really acts more like a liability, honestly, because, as we said, it can make you be cash poor. Even the principal, the equity that you’re building up in your house, if you don’t use it, what good is it doing to you? If you pay off your house, and you have a nice house and it’s sitting there, and you’re not actually taking the equity back out and using it for something, it’s not even really an asset–well it’s an asset, we both agree with that– but until you actually use the money, what good is it really doing? It’s not.

Holly: Well, Nate, I’m going to disagree with you a little bit. For us, if we have a mortgage on our house, we consider that a liability. Individuals do. But banks consider that loan an asset to them. So we need to start thinking exactly like you said. We need to start thinking like a bank thinks. And seeing our house as actually an asset and not the mortgage as a liability. And really start trading places with the bank. And using what they’ve given us to be able to create more money and income for the future as well. And one of those ways is many people have what is known as the HELOC, home equity line of credit. Do you do anything with a HELOC at all, Nate?

Holly: Nate, I just got in earlier this month … a notice saying, “Hey, do you want to create a home equity line of credit from the mortgage of [your] house?” I was like, “Hmm… I think I’ll do that.” Partly because number one: it was 2.4%. So interest- only mortgage, five years, that I can go to the bank and do. They were more than happy to do it because we had paid significantly for five years, never missed a payment. The house has definitely appreciated in value. And for them that is a good loan. So it’s a good asset just like the bank is thinking. But I’m going to take that money and I’m going to do exactly what you did with your principal and I’m going to put it in a participating whole life insurance because even if I have to pay the bank 2.4% in interest, and it is interest-only, but I’m earning 3.5 – 4% guaranteed on my money inside the policy then that’s a win-win for me and my family. And now I’ve just allowed my house to become an asset, because also if I graduate from this earth, I haven’t left my husband with that home equity line of credit debt and the mortgage on the house. In fact, the death benefit passes tax- free to him, and he has more than enough to cover both of those loans. So, in that regard, I’m actually able to make money off the bank’s money they’re giving me.

Nate: It’s beautiful isn’t it? More people ought to be able to do that. We get so caught up in wanting to get the mortgage paid off that we lose sight that if we get it paid off we no longer have the interest deductions, we no longer have the control of that money, that house is not producing us any profit as far as getting all that principal paid in. And we actually lose sight of the alternate form; we think the best thing we can do is to get our house paid off. I would actually rather — and this is a question I ask individuals, and I’m sure you would agree with me– my question is would you rather, let’s say your house is worth $500,000, Holly, would you rather have the house paid off or would you rather have a mortgage for $500,000 but also have $500,000 that’s earning you interest? Which one would you rather have? No money and the house paid off or have all the money with a mortgage?

Holly: I would rather have all the money with a mortgage. Just like if we pay off the mortgage what’s to stop you, if you actually own your home, then your best bet in owning your home, you still have property taxes, but if you own your home and there’s no mortgage on it, your best option today to continue to get tax reductions is to do an interest-only mortgage on your house and to actually have that and file that so that you’re able to take the interest and deduct it from your taxes. So we really need to start thinking big picture-wise. Some of us have paid off the house. Now we’re asking ourselves, what are we going to do? We’re stuck. What’s that next step? And a very easy solution is to create an interest-only mortgage on your house.

Nate: And we can even show you how to do that yourself. Or you can refinance. One of the things, Holly, and I just had this thought pop into my head, kind of back to what I said to getting your house paid off or having the cash, a lot of people think they’ll be in a safe position when they have their house paid off, but who do you think is in a safer position financially, looking at this whole picture? The guy who has no money but has a house paid off or the guy who is sitting on $500,000 with a $500,000 mortgage? Which one do you think can weather financial storms better?

Holly: Definitely the individual who has the money and the mortgage. And the reason being is, even with what Nate’s saying, as long as you can show you’re able to make the payments, you’re in a better position. But when you’re cash poor, you could have paid the mortgage off, and then all of a sudden you get hit with a property tax. And, guess what, it didn’t do you any good to have the mortgage paid off if you can’t pay the property tax.

Nate: Right. Cash is always king. You ask anyone in business– cash is always king. And the banks have convinced us to send them all our cash. And get these things paid off. And almost everyone out there is saying it’s the best idea if you can to get a fifteen-year mortgage, when it’s normally falling right into the bank’s hands. And that’s one of the biggest issues, as you just said, even if you have your mortgage paid off, if you have no money and you lose your job and your income drops down, the government can come take your house. For not paying the property tax. And the bank won’t give you any money back if you’re not making any money. So now you’ve got this house that you can’t even afford the upkeep and the taxes on. And the government will come take it from you.

Holly: Yeah, and I know that really big this year there’s been this big push to change to a fifteen-year mortgage, and there’s been a lot of advertisement around it saying the IRS doesn’t want you to know about this because it reduces your mortgage payments and you can save $3000 a year, $5000 a year, by changing to a fifteen-year mortgage. Well really, in honesty, you’re playing right into the government’s hand and the bank’s hand. Because, I just want to reiterate, with that fifteen-year mortgage you’re paying more money in principal with zero return, so you’re giving the bank’s more money to work with, and you’re, therefore, reducing your tax deduction to the IRS, and having to end up paying more tax because your money is going to principal and not to interest, and that is the deduction. So would the IRS love for you to refinance and do it for fifteen years? Absolutely. Would the banks want you to do it? Yes, because they’re getting more money, and it’s less risk for them. So all the way around this great concept of refinancing and the law that you can do this and save money actually plays into their hand, and it makes you cash poor.

Nate: Right, if it’s better for them, most of time that means it’s worse for you. If the IRS wants you to do it and the banks want you to do it, then it probably means it’s good for them, [it] doesn’t necessarily mean it’s good for you. And that’s key. Is there anything else on your mind about mortgages, Holly?

Holly: I think we’ve covered most of mortgage myths or what we believe are some of the biggest mortgage myths today. Nate, do you have anything?

Nate: No, I think that’s all I have, and I’m sure we could keep going … so I guess that’s good. Thanks for joining us, everyone, on this episode of Dollars and Nonsense. If you follow the herd, you will get slaughtered.

Holly: And to get your free resources and transcripts for this episode visitlivingwealth.com/e5.