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How to Earn Money by Borrowing at 6.0% and Investing at 4.0%

This article is about the benefits of proper mortgage planning and how they can lead you down a path to true financial freedom faster than you thought possible, even faster than an MMA can get you there. The goal is to show you how you may be able to use your mortgage to accelerate your financial and investment plans and grow your wealth more over time.

For starters, and to make calculations simple, we will say you take out a $100,000 mortgage at 6.5% (30 year fixed, fully amortizing) and invest the money in an investment vehicle earning 4%. This scenario is easy to find these days and in fact, investments can be found with higher rates of return while still maintaining liquidity and safety. We will presume that you are in the 33% tax bracket, because if you aren't you will be soon.

Here is what the net annual costs are related to the mortgage as compared with net annual growth on your investment account...

Year     Net Annual Cost @ 6.0%                     Net Annual Growth @ 4%
1                      $3,998                                                 $4,000
5                      $3,775                                                 $4,679
10                    $3,410                                                 $5,693
15                    $2,919                                                 $6,927
Total                $52,909                                               $80,094

As you can see in this example, in fifteen years, the difference is $27,185. What's even more dramatic is that when you use an investment that matches the interest rate on your mortgage at 6.0%, the difference grows to $86,747. Also, if your mortgage is greater, the numbers get even more dramatic.

Now, this is just comparing a fully amortizing loan with an investment account. Mortgage planning strategies take these much further using financing strategies that further enhance the difference and can accelerate your "debt freedom" date dramatically.

Posted by Florida's #1 Mortgage Planner on 04/25/2007 02:23 PM

Comments (21)

florida mortgage, mortgage planner, certified mortgage planner, cmps, financial advice, mortgage advice, client advice, equity management

21 Comments on How to Earn Money by Borrowing at 6.0% and Investing at 4.0%

APR

2007

Very interesting food for thought. Are you advocating borrowing $100,000 & investing it in say Fed bonds at 4%?

Michael...Thanks for the comment. Regarding advocating an investment, I do not advocate any one investment, nor do I advocate any one mortgage product.

What I do is take an in-depth look at the homeowner and their financial and investment objectives, utilizing a comprehensive questionnaire and discussion, then work together with them to find the best solution for them. The plan is always specific to the client, so I cannot advocate any one solution as it depends on the client.

The post was just to offer some insight on how easy it can be to make money and build wealth faster by not focusing on paying off your mortgage and get your money working for you instead.

MAY

2007

Very good, I always enjoy reading your blogs. You do have quite a nice way of explaining things that most people get easily confused about!

Tony...Thanks for the kind words. I will try to ensure future posts are of similar quality.

MAY

2007

Grea stuff, Robert. I love hhow you show how to use the tax advantage when engaged in "negative arbitrage"

Excellant!

MAY

2007

Brian...Thanks for the comment and stressing of the point. The concept is one that people need to understand and look at when analyzing all types of strategies.

Mary...Thanks for the comment.

MAY

2007

Very interesting. But aren't you showing the 6% in after tax dollars, and the 4% in before tax dollars?

Arnold,

The 6% is as a mortgage, so yes, the net cost shown is after tax. The 4% is also either after tax or tax free. Even tax free bonds are paying more than 4% tax free right now, plus you have more options by having the money seperated from the home, not to mention liquidity.

Robert - good illustration... I learned this from a Mortgage Coach disciple... and I definitely believe in this. It doesn't have to be bonds or funds or stocks or gold... it can be anything. I have a friend at a local bank in broward offering 5.14% in a money market account.... that is fantastic...

I think people miss the point of separating equity and assets.... and I think its particularly dangerous right now with the market where it is. I think a lot of people lost equity and didn't realize it wasn't real money. But I also think a lot of people that put too much money into their properties lost the cash asset AND equity which is what really hurts.

few people have the knowledge about how to use leverage properly... and even fewer financial planners know how to make it work on paper from their end.

until more people see how this works, there will always be a few of us Douglas Andrew faithful waiting for the chance to prove our worth

David,

Thanks for the contribution and you are absolutely correct. I just wish you weren't my competition. Aw, who cares if you are. Being right is being right.

Douglas Andrew is not the only one that advocates this, there is also Ric Edelman, Bert Whitehead (CFP), Sandy Botkin (ex-IRS), Sanford Mappa, and many more well respected professionals that truly understand the concepts.

Thanks again, and let's grab a coffee someday.

MAY

2007

what's competition??

Good point.

MAY

2007

Hi Robert,

I don't follow your analysis. You'll need $600/month to service the $100,000 mortgage debt at 6%, correct? If, instead of paying on a mortgage, you invest that $600/month at 4% you'll have over $147,000 in 15 years.

In your scenario, you end up with $180,000 in your investment account and still have a balance of $71,000 on the mortgage, for a net of $109,000. Oh, and you've made $108,000 in payments over 15 years($600/mo * 12 months *15 years).

What am I missing?

Andrew,

Thanks for joining the discussion. There are few things you are missing in relation to this post.

The first is that the mortgage is tax deductible, so the net cost is less than $600/month, hence why the left column is not $6,000 in the first year and not in multiples of $6,000 throughout the time period.

Secondly, you missed the point of the post. It is primarily to show how you can increase your liquidity and still make money doing that safely and you do not need to achieve high rates of return to do so. Another point is that the cost of a mortgage at the same net rate as your rate of retunr on investments is always going to result in your investments making money. The reason is that mortgages are straight line interest and your investments are compound interest.

Thirdly, here are the final details of the entire transaction...

Monthly payment of $599.95 times 180 months = $107, 991.10 (total paid P&I).
Tax Savings on interest (not invested) = $26,059.43.
Principal Added = $28,951.03
Net amount lost to interest =$52,980.64

Investment Deposit = $100,000
Investment Final (15 yrs at 4%) = $182,030.16
Current Balance on Mortgage = $71,048.97
Tax Savings on mortgage interest = $26,059.43
Net Remaining after Mortgage Payoff (and tax savings if not invested) = $137,962.38

While that would be a small price to pay for increased liquidity, it doesn't stop there. The saavings should be invested as well, so let's look at the annual savings being invested once per year (no return on the last year) like they would be if an individual waited until they received the tax returns. Here is how it would play out...

Investment Account if Tax Savings invested = $254,178
Original Investment Final = $182,030.16
Net difference = $72,148.28
Net Remaining After Mortgage Payoff if taxes were invested = $210,110,66

Yes, if you invested the monthly payment of $599.95 at 4%, you would end up with an investment account of $147,641.99, considerably less than if you invested your tax savings as you should. Additionally, by using your mortgage as a financial tool, you immediately have increased liquidity should you have a crisis, unlike monthly investments.

The advantages of using your mortgage as a tool are even greater when using an interest-only product.

I hope that helps you understand the ease at which you can make money using your mortgage as a financial tool. Please let me know if you have any additional questions.

Andrew, I forgot to mention that you can easily make more than 4% on your money elsewhere, so the difference is even greater.

MAY

2007

Greetings Robert....I am trying to put my mind around this. I realize that the point of your post is that the more equity you have in your home, the more at risk you are...I buy this...it makes sense. Moreover, if you can remove your equity and put it in a safe place...if the house burns down, earthquake, etc, you can walk away. Equity does not have a rate of return. I feel that is is 99% of what you are writing about. If you can get a zero return...you are in a safer position as you have control over your money...not the bank. That being said...should you not deduct 6000X15 from your 210110 considering you have already reinvested the tax savings? Would a more accurate statement be that your return would be $120,110? Hence, investing 600 a month at 4% would be the better strategy for making more money, but not necessarily the safer strategy...if we define safety as controlling our equity? Thank you in advance for your comments.

Mortgage interest MAY be deductible. Ok, it's almost always deductible, but may not actually lower your taxes. You have to assume that your other deductions already exceed the standard deduction in order to make all of your mortgage interest deductible.

I'm not in a state with high local/state taxes and even including interest on my home, which has a mortgage balance of $95,000, I barely exceed the standard deduction. So, the assumption that interest payments would be 100% deductible at 33% does not apply across the board and would turn this strategy negative.... especially as the years go by and the amount of interest paid declines and the standard deduction rises.

It also assumes that the $100,000 is a truly FREE mortgage (i.e. absolutely 0 origination cost), which I've never seen unless the rate has been jacked up and a pre-pay added.

I understand what you're trying to illustrate and agree that what you've described could work in some situations, but it's far from a slam dunk. Tax issues aside, if you look at the financial fitness of the average Joe, I'd bet he's better off leaving his equity alone as at least some portion would be consumed and not invested.

However, if I were in your profession I'd probably make the same argument. ;-)

So, where can I get tax free investments yeilding 6+%?

Thanks, Andrew

MAY

2007

Unknown commentor...My numbers accounted for all expenses, interest, etc., so there should be no reason to subtract the $210,110. I thought I made that clear. By reinvesting the tax savings, you will gain a significant advantage over simply applying the mortgage payments monthly into an investment account. The time value of money works to your advantage more that way.

Andrew...Mortgage interest is almost always deductible (AMT may prevent some of it). Most people that I work with far exceed standard deductions, and I always take that into account when working with my clients. Also, I never stated that the deduction will be the same for everyone, I just used the disclosed numbers in this example and they are quite accurate for most Americans.

Yes, this example uses a "no-cost" mortgage, but it is just that, an example. Again, it is designed to provoke thoughts and show how easy it is to use your mortgage as a financial tool to make money, which is what many of the wealthy do (I heard about 80%, but have not run my own numbers). Ric Edelman, in his book Ordinary People, Extraordinary Wealth, asked 5,000 of his clients who became wealthy what they did to achieve that wealth. The number one reason was using their mortgage to create that wealth.

Regarding a slam dunk, it is far from that, but the average American can do much better by seperating their equity, using their mortgage as a financial tool, and not leave it as "dead" equity.

FYI, I only work with about 50% of the people that approach me looking for help. My MEDS™ program helps me determine their goals/dreams and whther or not they are likely to follow through with the plan. Beyond that, their tax situation, suitability factors, etc. may prevent them from being able to take advantage of the program. Also, you would be surprised how many people come to me that have used their house as a personal ATM machine, consuming their equity instead of investing it.

I do not do this for business, and in fact, as I have blogged about it before, since I also fly for American Airlines, I may not be originating loans much longer as I do not have the time to do both jobs. But even if I do quit doing mortgages, rest assured, I will still teach these concepts as they are solid and can help many Americans achieve true financial freedom that otherwise would be unable.

JUN

2007

If I re-invest the interest saved by pre-paying a mortgage debt... doesn't that turn the mortgage into a compounding vehicle which is basically no different than any other investmetn at the same discount rate?

The tax effects should basically wash out, unless I am hitting a mortgage interest deducton ceiling... in which case an alternative investment should be preferrable by only the differential in tax savings? correct?

JUN

2007

Sam,

in a sense, it does compound the interest down, however it is not the same effect as it is limited time frame. Also, you are left with nothing in your investment account at the end, whereas applying it to the investment account, at the time of "mortgage payoff" you have a large amount of money working for you.

The tax effects are not a true wash out since you receive less deductions the faster you pay off the mortgage. So, your tax savings are better by paying less towards your mortgage.

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