In the last installment, I reviewed why Ric Edelman, author of the best-selling book, The New Rules of Money, states that homeowners “...should get a big 30 year mortgage and never pay it off.”

In this article, I will compare two brothers with different thinking when it comes to borrowing money for a home.

Brothers A and B each earn about $70,000 per year. They each have $40,000 in personal savings and have each purchased a $200,000 home.

Brother A spent more time with Grandpa and was taught that he should get the shortest and smallest mortgage loan possible and then pay it off as soon as possible.

So, Brother A demanded the following of his mortgage professional:

15 year mortgage loan at 5.25% (5.56% APR).
$40,000 down payment
$0 left to invest as he put in all into the house
$1,286 monthly payment (which is 56% deductible in year 1 and about 28% deductible over the term of the loan). We know that the amount of interest expense is higher as a percentage of the payment in the early years.
So, his average monthly net after-tax cost of the loan is $1,159.
In order to pre-pay the loan, he sends an additional $100 to the lender each month.

Brother B, respects his Grandpa but just attended a seminar on how to “Harness the Power of His Mortgage”, decided to do the following:

30 year INTEREST ONLY mortgage loan at 6.125% (6.32% APR).
$10,000 down payment leaving him $30,000 to invest
$970 monthly payment (which is 100% deductible for the first 15 years and 59% over the life of the loan).
His average net after-tax cost of the loan is $660 per month.
He decides to save an additional $100 in his investment account each month plus the $499 he is saving from his lower interest-only mortgage payment.
His investment account earns an average of 8% each year.

Who made the right decision? Well, let’s review the results after just 5 years.

While Brother A did receive $7,620 in tax savings over the 5 years, he has $0 in his savings and investment accounts.

Brother B received $18,600 in tax savings and now has $89,299 in his investment accounts after just 5 years.

What happens if they both happen to lose their jobs at this point?

Brother A:

Has no savings to get him through the crisis.
Can’t get a loan – even though he has $86, 951 more in equity than his brother – because he has no job.
Must sell his home or face foreclosure because he can’t make the payments
At this point, it’s a fire sale and he must sell his home at a discount and then pay an agent 6-7% commissions.

Brother B:

Has $89,299 in savings to get him through the crisis.
Doesn’t need a loan.
Can easily make his mortgage payments even if he’s unemployed for years.
He has no reason to panic since he is still in control. Cash is King!!

This is after just 5 years. What happens at the end of 15 years?

Brother A:

Received $20,650 in tax savings,
has $27,996 in savings and investments and
Owns his home outright.

Brother B:

Received $55,800 in tax savings
has $305,886 in savings and investments and
his remaining mortgage balance is $190,000
- he has enough savings and investment to pay it off still leaving him $115,886 in savings plus the value of his home.

So, you see? Brother B’s loan was no riskier than Brother A’s loan. In fact they were both fixed rate loans. One simply used the interest only feature to accumulate wealth. A mortgage is not the unwieldy beast we have been led all these years to believe it is. On the contrary, it is a tool that, when its power is harnessed and properly used, can generate substantial wealth in the lives of the holder.

For a complete mortgage and debt analysis and to learn how you can harness the power of your mortgage, contact me at kpearce@CPALoanPro.com. Keith Pearce is a CPA, mortgage and real estate broker.

Harness The Power of Your Mortgage - Part 2