The following is the transcript from Episode 19 of Retire Happy with Roger Gainer, a financial and business audio podcast.
Roger: I think the decision to finance your principal residence is one of the most impactful decisions you can make when it comes to your personal financial security. The wrong decision can cost you big time and force you into making some very, very uncomfortable awkward and negative decisions on your own behalf. So head that off at the pass by making wise decisions around your mortgage.
Clark: You’re listening to Retire Happy with Roger Gainer, President of Gainer Financial and Insurance Services, Inc. Thanks again for joining us. I’m your host, Clark Buckner.
One of the most important financial decisions you can make is to own or finance a house. Over the past decade, it’s become increasingly difficult for many people to buy a house or keep up with a mortgage that they already had. In this episode, we’ll cover the challenges of homeowners and prospective home buyers face and what you can do to avoid those obstacles. Along the way, Roger will share with us the best time to pay off your mortgage. For more content like this, be sure to visit gainerfinancial.com. Enjoy the conversation.
Well, Roger, welcome back. I’m really looking forward to digging into today’s topic is all about when is it a good time to pay off a mortgage? And is there a good time and all of the above? But first, how are you doing?
Roger: I’m doing great. Really, really enjoying some of the well some of the new things we’re doing here at Gainer Financial. We’ve been working on some new initiatives and I’m pretty excited about them. Hopefully, we’ll have some announcements in a future webcast, but we are adding services and incorporating some new folks here at the office. And so it’s an exciting time as far as I’m concerned.
Clark: You’re always doing new and exciting things. So let’s jump right in. So you wrote a post, this is a couple of years ago and it’s titled, Should I Stay Or Should I Go: Tough Choices For Retirement. And more or less it’s just examining how sometimes people get to the point where they’re forced to sell their home just to afford their living expenses and care. So our conversation today is trying to help someone avoid getting to that point when their hand is forced. And so that’s kind of the whole context.
Roger: Well, I do consider this one of the most important decisions that people make is how do we own and finance our house? For most of the people I work with, because I do work mainly with middle-class folks, their house represents a very significant asset in their overall financial life. And when I wrote that post, Should I Stay Or Should I Go, it was because I just had a succession of new people coming to see me who they were hurting. They owned a house here in a beautiful area. We live in Marin and we have very expensive real estate as most people know. And here they were millionaires because they owned a piece of property, but they were worried about paying their taxes. They were worried about maintaining the house. They were worried about having enough to eat and in some cases, they had health issues that they needed to address and they just didn’t have the cash flow or the money to do those things.
So I started researching because this was coming up over and over and over again. And then I started realizing this isn’t just something that happens here in California or Marin County. Really, it’s relative, it happens all over the place. It’s one of the saddest things in the world. You live in a house for decades. You raise your family. Now, you’re looking forward to kicking back and really enjoying the house. It’s like putting on an old pair of sneakers. That house gets comfortable after a while. Certainly, of the big issues that I talk about with my clients is can you age in place? Most people tell me, “I really want to stay in my house.” If you got a lot of stairs or you live on a hillside or something, you may have other reasons, but when it’s really unfortunate is when economic reasons take you out of the place you intended to live for the rest of your life. And I find that a profoundly sad.
Clark: To follow-up on that, so this is basically around the considerations that someone should be thinking about and when someone asks you, “Is this a good time to pay off my mortgage?” Let’s transition over to that. When people are getting their hand forced on something did they, do they still have a mortgage, and they paid it off? What’s really happening beneath that? And how can you avoid getting in a tight squeeze?
Roger: Well, it’s a great question because, and it’s one I’m really surprised. I understood back in 2008, 2009, 2010 people were just nervous as all get out by the stock market and this and that. In fact, I just had this call yesterday from somebody who was looking to buy a new house and they were asking me about financing and paying it off. And last week I had somebody contact me when we posted this blog post I received responses from folks thanking me for the analysis because they were struggling with this very issue. It’s certainly something that is on people’s minds. So how do you decide if it’s a good time to pay off your mortgage?
The first thing is like most folks I see the damage that failure to do a good job of managing debt can cause. But a mortgage debt is very different than credit card debt, student loans, car loans, those kinds of consumer debt. When you’re paying something off in installments that is losing value or not retaining value or is guaranteed to lose value, just like your car, right? You drive that car home, that brand new car just lost 20 to 25% of its value, just leaving the lot and heading to your house. Now, you’re what a lot of people call underwater the second you buy that automobile. But a house is a little bit different.
First of all, the houses is much bigger and a lot of this notion of paying off our mortgage came from our parents, the generation that grew up and bought houses in the 50s and 60s and even earlier than that. And their parents, our grandparents, who saw their neighbor’s losing their home to the banks back in the 30s during the Great Depression.
And so this fear of being beholden to the bank became pretty common actually, “Gee, my neighbor made their payments for years, and then the bank took the house anyway.” Now, I want people to understand, first of all, that can’t happen anymore. There have been lots and lots of new laws and rules put into place to protect consumers from having their mortgages called. And I’m not going to go into exactly how the Great Depression occurred and it’s ramifications on the banking industry. But if any of our listeners want to have that detail and that background, give me a call. [crosstalk 00:08:24] It’s really a fascinating story and I’m happy to share it.
But today you cannot have the bank just say, “Pay off your mortgage in 30 days or we’re going to take your house.” That just can’t happen anymore. And the other thing is, for our parents who bought houses in the 50s and 60s, they paid 20,000, 50,000, maybe 70,000 for a house, a really big house, and it only represented a fraction of their overall financial picture. They had pensions. They had relatively larger Social Security benefit and so it was just kind of 10, 15% or less of somebody’s overall financial picture.
Today, it’s not uncommon for somebody home to represent 40, 50, even as much as 70% or more of somebody’s overall financial resources. So the decisions you make when it comes to financing, owning, paying for your house have significant, not just short-term ramifications, but long-term ramifications.
Clark: As you’ve written before. There’s been a lot of people who think their house has been their best performing asset and it sounds like one of your responses is clearly that it isn’t true. Could you tell me a bit more about why that’s the case, especially through that lens that you’re talking about right now? Just why this day …
Especially through that lens that you’re talking about right now, just why this debt is different. Why a mortgage is just different than other debt.
Roger: I’ll use my house as an example. We bought the house we live in, in 2004. And since that time, the house has almost doubled in value. So that seems tremendous. I mean 14 years doubled my money, it’s appreciated hundreds of thousands of dollars in value. We don’t know that for sure, I’m not selling the house this week, but at least on paper it’s virtually doubled in value. And a lot of people say, “Wow, look at all those hundreds of thousands of equity you’ve got now.” But the thing to understand is first of all, over 14 years doubling your money means you made about a 5% rate of return. That’s an awful lot of things over the last 14 years that would’ve returned 5% compound returns and more.
And that 5% does not include the cost of ownership; the taxes I pay, the home owner’s insurance that I pay, the interest I pay on my mortgage, and it doesn’t not count the maintenance on the property. If we factor all that stuff in, even here in one of the hottest real estate markets in the country for the last 10, 12 years, we’re only slightly ahead. So I think of a house as an asset, like you said before, but certainly not as an investment. An investment is something that pays you.
So a house is kinda like having another kid, only sometimes it’s a lot more expensive than having another kid. You pay it. And you hope it appreciates and it gains value. It’s not a guarantee, there’s a tendency for people to always believe that their house goes up in value. I had an old friend and client recently who had moved to a new town to be closer to the rest of his family and his grandkids, and the house he left, which was a beautiful house, he was the only owner. It took he and his wife almost a year and a half to sell that house. And they had to cut the price by $150,000 just to get it sold over that timeframe.
And that price cut meant that they lost money on living there. Now, there are other reasons to own a house than making money. And unless you’re a house flipper, those things should be your primary influences on your decision to purchase a house in the first place. What we do here at Gainer Financial is we just wanna minimize the economic damage that paying for that house incorrectly can create.
Clark: You talk about economic damage, I’m curious about economic factors that may be considered based on the time that someone is on maybe paying off or not paying off their mortgage. Or maybe approaching it in a certain way. You mentioned some earlier dates; 2008, 2009, different time than it is right now. But what are some economic factors someone should be using in this general consideration mode?
Roger: Sure. Well since you brought up 2008 and 2009, one of the things that people forget is during that era, that downturn was largely caused by a lack of liquidity. So think about it, if your house is work $500,000 or $1 million and you don’t have a mortgage and that’s over half your money and you need to access that capital, you’re not in control of your money. You have a gate keeper. You either need a buyer or a banker to cash you out. You can’t just go out to the porch and knock a few bricks off, run down to the local Safeway and say, “My house is work a half a million dollars, here’s $100 worth of my property I wanna buy dinner tonight.” They’re gonna look at you like you’re crazy. So you have this asset, but what is is really doing for you?
You hope it’s appreciating, you do have pride of ownership, but when you stop and think about the rate of return your own equity is earning, it’s zero. Now, I know there’s some listeners right now that are going, “Wait a minute, wait a minute. My house went up in value, that means I made money on my home equity.” But if you stop and think, the value of the house going up has nothing to do with whether I have a mortgage or I don’t have a mortgage. The house goes up and down in value based on the market, not my financing. So that’s how you know that your home equity is guaranteed to earn you a 0% rate of return.
Now, Clark, if I came up to you as a potential client and I said, “I’ve got this fantastic investment. You get to make monthly contributions. If you miss a few months of contributions however, you might forfeit all the contributions you made to this account previously. By the way, when you put money into this account, every time you make a deposit your taxes are gonna go up. And oh yeah, the money that’s in the account, you can’t get it back. It’s not liquid. Maybe in the long-term you might be able to receive some of that, those deposits back. But in the short run you can’t get them back out once you’ve made those deposits. And oh yes, your money is at risk, you might lose money, you might make money, but you won’t know for years, and years, and years, how much would you like to invest?”
You’d probably ask me to leave immediately. But that’s what most mortgages are doing. You’re paying down your principle, and every time you make that payment your taxes go up because the amount of deductible interest goes down. That money is now part of your equity, but you are not in control of that equity, you cannot get it back. And your guaranteed rate of return of 0%, it’s not that hard to make more than zero. I mean zero’s great if the market’s dropping by 50%. But if we can make interest of even 2, 3, 4% that’s way better than earning zero. That zero become a stranded asset that’s really kind of a drag on your overall performance.
So Clark, liquidity is one of the most under-appreciated or over-emphasized elements of financial planning. Most people want liquidity in areas where they don’t need it, or maybe it’s to their detriment. We’ve talked about that before with higher risk type assets. But with home equity and that loss of liquidity, if you just dial back 10 years and you look at so many people that lost their homes or lost their real estate investments, it was because they didn’t have liquidity when things fell apart.
I hear from people all the time, “Well I’ve got an equity line, I don’t need liquidity, I can write myself a check anytime.” Well it wasn’t that long ago, back in 2008 and nine that the banks froze everybody’s home equity line at the outstanding amount of debt. So if you had a $250,000 home equity line and you borrowed $35,000 say. One day you went to write yourself a check and they said, “Oh you’re maxed out on your equity line, which has now only got $35,000 of available credit.” And the banks had to do that because they didn’t know what the value of the collateral is. That collateral, that’s the key concept here, what makes the debt on a home or a piece of real estate different than the debt we talked about earlier on a car payment or on your Visa card.
It’s that notion of collateral of a store of value that is backing the debt. So we use a different sort of process. And I’m not a big fan of debt, I mean sometimes we use that leverage because we have to, to buy the property. But in the long run, managing a mortgage can actually make it safer. So if we got two neighbors; neighbor number one buys a house for $1 million, pays cash. Neighbor number two, they could pay $1 million in cash, but instead they take out an $800,000 mortgage and they put their $800,000 into a very conservative account earning say 3 or 4%.
Clark: And when you say a conservative account, is this … What kind of account is that?
Roger: Well we don’t wanna speculate with your home equity.
Clark: No speculation, okay.
Roger: So we’re not gonna buy penny stocks, or go play in the commodity markets. We’re not gonna be looking for IPOs. We’re not going to be looking for IPOs and that sort of thing. It’s your home equity, you don’t want to put it at risk.
Clark: But what you’re saying, instead of just putting it straight up on paying that house, just keep it somewhere really safe, but it might be having a little return?
Roger: Right, which helps to reduce the cost of owning the house, actually.
Clark: So, 34%? That’s not going to be a savings account. Again, I guess we can’t speculate.
Roger: We have lots and lots of very conservative options that are going to earn three to 5% without risking your principal. If any of our listeners want to talk about what those kinds of things are I don’t talk about product on these broadcasts.
Clark: Right, we need to come talk to you.
Roger: I don’t want to be specific.
Clark: Everyone’s different, every situation is different, right?
Roger: Right. And what’s appropriate for one, may not be appropriate. Today, I really just want to emphasize the strategy, and being in control of your personal financial situation. See, if you keep that 800,000, I don’t need a banker or a buyer to cash me out. I’ve already got the cast. Oh, by the way, I know it’s hard for people around here to believe, but like I said about my friend who lost money on his house, if that equity is outside of the house, and the house value does go down, I still have my equity. I didn’t get squeezed, so I actually-
Clark: That is very interesting. I never thought of it like that.
Roger: Yeah. Okay, I’m in control of the equity. And in a lousy market like we had in ’08, ’09, when you couldn’t find a buyer unless they were going to pay you 30 cents on the dollar, that’s what people were buying houses for, 30, 40 cents on the dollar, sometimes less. If I had that equity I could go out and find a non traditional buyer, because I don’t need them to cash me out, I just want to get off title. So I can go and do a lease option, I can do an installment sale, I can lend back the down payment, they can go get a conventional loan. So, in a bad market, I broadened my potential market for buying my property. So, there’s all kinds of layers to this. But one of the concepts I try to teach is called lost opportunity cost. That’s the silent killer of building wealth. And lost opportunity cost, as we’ve taught before, Clark, every dollar you touch you can only do two things with it. What are they?
Clark: I guess you can spend it or save it?
Roger: That’s it. Those are the only two things you can do.
Clark: Okay, good.
Roger: You get an A today. And when we save it we want to earn a rate of return. When we spend it we lose the opportunity to earn a rate of return. So, that’s the lost opportunity cost, that’s the cost of financing. So, if we paid cash for that house, that million dollar house, and i can make 5% somewhere else, my house better go up in value by $50,000 a year just for me to break even. And that’s not counting the ongoing cost of ownership. So, one of the things I’m hearing a lot of on the radio, and on television, and seeing ads in the paper these days, is for shorter term mortgages. And I just want to put out a little warning on that. People are saying, “Don’t you want to get out of debt? Take a 10 year mortgage, take a 15 year mortgage, and pay it off.” Well, I would encourage you to take a 30 year mortgage and bank the difference. And if you earn about 3% on that difference you’ll be able to pay off the house in less than 15 years.
But, 15 years from now you just don’t know if that’s your best move. So, this buys you much more flexibility and control if we pay off that mortgage on our balance sheet. If I know at any time I can pick up the phone and I can transfer the money out of an account and pay off that mortgage, and most accountants will tell you, you’re balance sheet is in balance. There’s not debt net. And that’s a critical factor to understand, because now, using the same asset as the guy who paid cash, I am diversified. I have money for opportunities, I have money to face downturns, I have liquidity for opportunities. And the other thing that people don’t understand is something called Gresham’s Law. Gresham was an economist to the British Crown, I believe back in the 17th century, and he came up with Gresham’s law, which says, “Good money is forced out by bad.” If you think about it, back in 1973 I could send a first class letter for eight cents. Today that same letter costs me almost 50 cents. So, that’s what we mean by good money being forced out by bad.
A dollar tomorrow is not going to be as valuable as a dollar today, it’s not going to buy as much. Does that makes sense, Clark?
Roger: So, the bank loves these short term mortgages, because today’s dollars are going to be the most valuable ones. So, if they can get your more valuable dollars back they get to turn that dollar over, and over, and over again. It’s much more profitable for them. If we have 3% inflation that means that my mortgage payment out 24 years from now is only going to be worth 50 cents versus today’s dollars. You follow that?
Clark: That’s right.
Roger: I want to pay the bank back with less valuable dollars, I want to keep as many valuable dollars for myself. Does that make sense?
Clark: Yes, that makes sense. It’s one of many valuable tactics, and strategies, and options that I know you work with your clients on. So, the final thing to mention, a next step someone can take with you, is something I’ve heard called the mortgage master analysis. So, what is that, and how could that potentially help someone think through their current situation, and look at all the options?
Roger: Well, a mortgage master analysis helps you to understand the true cost of your mortgage. Because mortgages do get some tax benefits, you need to include the value of those benefits in your analysis. So, I’m offering anybody listening, they can come in and we can run an analysis so you can see the actual cost of your mortgage, and you can compare it to other refinancing options. As a full disclaimer, I do not do mortgages, I do not sell mortgages. I do know a lot of great mortgage brokers if you don’t have a great one, or I can help you to train yours to give you the kind of mortgage that really serves your overall financial plan. I hear people advertising a 15 year mortgage actually costs less, will save you hundreds of thousands of dollars in interest, and that plain isn’t true. And I can show you, and demonstrate, and help you to understand that, so that you can free up money to help secure a happy retirement for yourself. So, just call the office. It doesn’t take a long time, we gather a little info.
You bring in a mortgage statement, we plug it into the software and we walk through the tutorial so that you will understand exactly what’s going on.
Clark: Got it. Thank you, as always, Roger. Enjoyed our conversation, and I can’t wait for our next dialog around these really important topics.
Roger: Thank you, Clark. Things definitely stay interesting around here.
Clark: Thanks so much for listening to this episode of Retire Happy. Be sure to head on over to GainerFinancial.com to download your thought organizer to get started. Roger L. Gainer, CHFC, California Insurance License #0754849 is licensed to sell insurance and annuity products in California, Illinois, Arizona, Pennsylvania, and New York. Roger L. Gainer is an investment advisor representative providing advisory services through HFIS Inc., a registered investment advisor. Gainer Financial and Insurance Services, Inc. is not owned, or affiliated with HFIS Inc. and operates independently. Thanks again so much, and we’ll see you next time.
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.