PODCAST EPISODE 184: Asset Investing Series (Part 2): The Trick Question of 30YR v 15YR Mortgages

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Paul 0:01

Welcome to your business your wealth, where your hosts Paul Adams and Corey Shepherd teach founders and entrepreneurs how to build wealth beyond their business balance sheets.

Hello, and welcome to your business, your wealth. My name is Paul Adams. I’m joined by Corey Shepherd, president of sound Financial Group, who is always here to keep track of me and make sure that for all of you, you have this amazing content that helps you better design and build a good life. Cory What do we have in store for everybody today?

Cory 0:54

I just want to point out that Paul is the CEO and founder of sound bites. stands for group. Just so y’all know who’s with me here.

Unknown Speaker 1:03

Today, I just resigned as CEO.

Cory 1:06

We just had a talk about how he swears he never forgets my title. And he just gave me mine didn’t give him his I gotta make.

Paul 1:13

I’m gonna do four or five of them this way, Cory just so we get it even rebalances.

Cory 1:18

So I’m really excited about our episode today, because it’s actually these kind of conversations we’re having in this series about asset class investing, have been coming up with clients left and right. And in, especially in the market, doing these movements, largely due to COVID. We think although we never really know what the why the market does, what it what it does, but things like mortgages and real estate investing because of where interest rates are, are really high on the conversation timeline right now. And there’s, there’s a lot of strategy to that goes into it and a lot of assessments to change Check and questions to ask. And we’ve got a trick question to start with today. That’s the title of our episode. And the trick question is the bank asking you if you want a 15 year 30 year mortgage, when you walk into the bank and start start that underwriting process, we’ll come back to why that’s a trick question. But Paul, I think you’ve got a great way to set the stage for folks to start thinking about this.

Paul 2:25

Yeah, I here’s what I’d have everybody just ask themselves as we’re sitting here talking today, you’re driving your car, you’re out on a run. Depending on what state you’re in, you might even be at the gym while you’re listening right now. And here’s what I want you to put you in the position of is imagine you’re going to lend $400,000 to somebody. And right now is historically low interest rates. So you’re getting a relatively low rate of return on your money that you’re going to lend somebody. Let me just ask you, would you want them to pay it back roads Simply quickly over 15 years, or would you rather them pay you over 30 years? Now, every time we ask somebody that question, everybody says, well, gosh, if I’m at risk of somebody paying it back, I’d rather get it back more quickly.

Cory 3:19

And what I’m thinking is, if I’m in the business of lending and rates are super low, you know, I’m selling apples and the price of apples has gone down like crazy. If I’m a bank, I want that principal. The principal is more important than the interest by capital that I have to lend. I want it back as quickly as possible so that I can lend it out again and hopefully at a higher interest rate next time around.

Paul 3:46

Indeed, indeed, and yet we all sit there all the time, thinking that perhaps and this is no admonition of your banker. I’m not meaning to down talk in this specific case. Big Box financial retail that puts these tools out there. I’ll reserve that for future podcasts. But it really does seem that way you even see it on people’s faces. When they say, Well, my banker, or my mortgage broker recommended that I do a 15 year, I’m going to pay less than half the amount of interest. Now, the reason it’s less than half the amount of interest is because you’re only paying it over 15 years. Except the way we noticed most people kind of relate to it is based upon the interest rate that Yeah, I know it’s it, I gotta pay it off faster, but I get a quarter point lesson interest rate, and we relate to it that way. Even though this is an institution that we’re paying money to, and they just told us how to pay them less than half the amount of money and yet we look at it go Oh, they’re probably taking really good care of us. That’s our kind of initial reaction. But for any of you out in the workforce, running a business, almost none of you would go to your employer and say, Hey, here’s what you can do to pay me half as much, or as a business owner wouldn’t go to all your top customers and say, here’s what you can do to pay me half as much as you’re paying me before. Because that would immediately get treated with an appropriate amount of distrust. And yet banks say to us all the time that we think nothing of it, and we actually think they’re doing us a favor. So why is it Cory that they even want to give I want people to be in the 15 year?

Cory 5:36

Well, it’s the same reason that I just said, although it’s not just limited to historically low interest rates, banks are in the episode of Lent, to Episode zarb. So back to the business of making money by lending and so the more lending they can do, the better that that. I don’t want to call it velocity because that takes And all kinds of different directions. But the sooner they can get that money back to lend it out again, the better for them. Yep. And this is not the episode where we’re talking about fractional reserve banking but, and that’s why I don’t want to talk about velocity of money and all those those kind of things. But you’ve got some examples of that. I think you’re going to share indeed. So let’s

Paul 6:22

just talk a little bit about what is the difference. So I’m going to, I’m going to share this on the screen and then we’re going to talk a little bit about the actual mathematical difference between the two scenarios. So we have two loans being compared. So for those of you listening on the podcast, you can go to the podcast episode page and be able to download some of these visuals. For those of you watching YouTube for this episode. All you have to do is open your eyes and look at the screen. We have to compare these two situations being compared a 30 year mortgage of 400,000 at a 3% interest rate on a $400,000 mortgage at two point seven 5% interest over 15 years. Now you can see the difference in payments on the screen one’s costing just under 1700 dollars a month, and the other is just over 20 $700 a month. So there’s about $1,000 difference between the two payments. And when you look at the cumulative interest rate going back to how the bank positions it is you can pay us less interest. The 30 year loan has cumulative interest of $207,109 and 81 cents. But the 15 year has cumulative interest of 88,000 607 and 58 cents.

Cory 7:41

So, man, if that’s all you were looking at, of course, who in their right mind, why would you take a 30 year if you could help it? Why would

Paul 7:50

you pay four bucks for a gallon of gas if you get the same gallon of gas for $2? Nobody. So maybe they’re not the same gallon of gas So, Cory share a little more, but just a touch about how you notice people may be getting beyond just the interest rate and having a little more strategy.

Cory 8:12

So, you know, when I’m looking at something like this, and we, by the way we do know, bankers or mortgage brokers that think, in similar ways that we do think broadly to look at that whole, the whole picture and the good ones are gonna say, you know, this is not the whole story. Because the whole story is taking a look at the difference between the mortgage payment in a 30 year and the 15. And saying, what would you have been doing with that? In a 30 year mortgage along the way, if you were just throw it in the trashcan, then yeah, pick the pick the 15. But if you were going to be doing something with that, then that’s a bigger part of the the story and so, you know, just like a, in a low interest rate environment, the principal is more important than the the interest here, we’re looking at 3% versus 2.75. So the difference in interest rates is nowhere near as important as the difference in cash flow and the difference that you’re using with that money over over time.

Paul 9:15

Well, just just to pick on this a little bit in the first year on 400,000, a quarter percent interest will be $1,000 in interest difference in the first year on that quarter percent difference in the two mortgages, a quarter percent on 400,000. Is $1,000. In that first year.

Cory 9:41

Yeah. 12,000 and change difference in cash flow.

Paul 9:45

Yes. The other way, meaning the 30 year mortgage Yeah, takes $1,000 less. So month, per Yeah, for month more. So we adjust on the interest rate difference. We save $1,000 a year on 400,000, at least the first year before the principles change between the two mortgages. And we can look at that and go, Wow, that thousand dollar difference if that’s what we’re analyzing great, but we have a $12,000 difference annually in cash flow to the household in both of these mortgages. So we talked a little bit in our last episode number 183, about how banks make money. Now we’re just going to look at a quick slide from that episode, just to reiterate this, is that we often can feel like we’ve got three and a half percent is what we’re paying to control a piece of money and then getting a 6% return. And when we look at that, and certainly the way the banks would prefer us to learn about it, it feels like a two and a half percent rate of return to most people. That’s the difference between the three and a half percent. And I paid and the 6% I earned. But like we talked about in the last episode, the additional equity in our home has zero return. Additional equity in your home has a zero percent rate of return. The reason that is, is the home appreciates that the exact same rate, regardless of how much equity you have or not, because it appreciates on its total value.

Cory 11:26

When you have to sell the house to actually get that rate of return, it’s all fake math into actually have someone write you a check for it in the hole. And if we’re talking about 15 or 30 year mortgages to the end of that term, then we’re just assuming we’re not selling the house. So that is no money back to our household.

Paul 11:45

Yeah, exactly right. But we do and it is legitimate that we are paying a cost of money. to us that as represented in our previous episode is three and a half percent. But that’s not a two and a half percent rate of return. It’s at for every hundred thousand dollar We’re controlling, we’re paying about 30 $500 a year. But the return if we get 6%, on average over time, the return of 6000 against just making the interest payment to control our capital is over 70%. Now, that all looks more substantial when it’s on 100,000, but it’s no difference, whether it’s 100,000 of additional downpayment, or it’s the difference of $1,000 a month in monthly payment on that mortgage. Now, before we go to commercial, I just want to make kind of one subtle point. And as I click here, what you’re going to see how what rate of return minimal rate of return Do I have to get on my extra thousand dollars a month, to be able to have that grow to be enough to pay off the mortgage in 15 years? So let’s say I choose I want to control my cash flow. But I would still like to have a paid off home 15 years. Remember, we talked about a little bit in the last episode, the two safest places for somebody to be is a home fully leveraged, or home totally paid off. It’s the in between where we have like 50,000 left to pay on a million dollar home that we really can be in danger of going into the green pile of the special assets division if we ever had to try to negotiate payments with the bank. So what return Do we need just to pay it off in the same timeline? drumroll please. 3.57%

Cory 13:37

and it does say net after taxes, I want to point out that we’ve left tax brackets at zero to totally leave taxes off the table of this equation because, frankly, the government’s already changed the benefits of interest tax deductions in the last few years. It’d be an easy thing for politicians to continue and just take off the table entirely. So we’re doing that here,

Paul 13:58

but in reading did run it with a 30% tax bracket prior. And all you had to earn was like 2.8% to just pay off your mortgage in 15 years. Now, most of you listening probably don’t consider yourself Warren Buffett when it comes to investing. But nearly everybody we have a conversation was like, well, I could outperform three and a half percent over time. And that’s the hurdle rate it would be to still have the home paid off in 15 years. But let’s look at it all go.

Cory 14:32

Something just occurred to me our conversation around the bank wanting us to pay it off faster, so that they can hopefully lend it out higher at a higher rate later picture in 15 years, if interest rates have crept up that whole time and now mortgages are in the six and 7% range and your savings account pays you for let’s just say well, then You might want to be able to make the choice to just let that mortgage ride, as they say, keep that money growing at a faster rate and continue to pay down that mortgage as soon as possible. Now you’re doing exactly what the bank wants to do for themselves. But for for you when you have all the control

Paul 15:18

in the late 90s when I got into this industry originally, so yeah, I’ve been around a while it’s been 23 years. I’m still all the gray

Cory 15:26

is on the underneath of the beard. That’s right, but it’s there.

Paul 15:29

Yeah, yeah, I’m still working through my issues around having done something for two decades running. But the thing to consider is my money market account, when I first got in this industry was paying four and a half 5%. And that is not that long ago. When those times happen again. Now you’d want control over your money and your mortgage and choose whether or not to pay it off. Now, one other just small note, and then I’ll have Corey tickets to commercial But this is just kind of sharing from my heart in something that we’ve watched nearly universally. And that is that if somebody is buying a big ticket item, whether that be a home, an RV, a large boat, etc. The way people go about financing that purchase and the way that they think about the purchase, versus if they have a check that they can write, to make that big ticket item purchase. They’re entirely different decision sets. People negotiate differently, people do all those things, because that loan that you’re taking is a lien against your future capacity to earn an income. The collateral whether it’s the car, the boat, the RV or the home, is the thing that they take away from you, as a societal consequence for you not paying your mortgage. There’s nobody who buys an RV with a 20 year loan on it and they drive it off the lot. It drops 30% in value that if the bank came into If that tomorrow, they would get nowhere near their loan paid off. Right? They are leaning against your future income or your other assets. In this case, I just want for all of us to think about that you’re probably going to feel it feels a little bit different. It’s just thousand dollars a month different to a 15 year mortgage, it will feel very different than that. If you’re looking down the barrel of Okay, now I’m going to write a check to pay off this mortgage for over 200,000 in 15 years. And you might find you’d rather control your money and just keep letting the bank take its payments, because there’s another thing that’s helped you, Cory just share a touch before we go to commercial about what inflation does in a positive way to that mortgage payment.

Cory 17:43

Hmm. So if you’ve got a 30 year mortgage payment, what was the what was the payments on there?

Paul 17:52

100 just under that.

Cory 17:54

I’ll go back to 100. Yeah, so you know as inflation creeps up over time, that mortgage stays level. So that 1700 dollars costs you less and less every year because you’re still getting paid an income that is inflating over time. Or if you are, if you have at least cost of living increases in your in your income. So that means, you know, 15 years from now, that mortgage could actually cost you half as much even though it’s still says 1686 42 on the payment. Yep. Every year. That’s a beautiful thing. It’s it’s one of the cases where we can make inflation work for us in a very beautiful way. So with that, we’ve been we’ve been talking a lot about the trick questions of 30 versus 15 year mortgages and when we come back, we’re gonna talk about some solutions and really let you know what the answer that trick question is. So stay with us.

Paul 19:00

Paul Adams here at sound Financial Group. Are you curious what you can accomplish with our help? You’re here enjoying the show. Our philosophy is helping you increase your effectiveness with money. And now we have a way to help you take another step on your financial journey. We have designed a financial inquiry call for you and the thousands of other listeners of your business your wealth. This is a complimentary 15 minute conversation where one of our team members will ask you some key questions. understand your concerns, and if appropriate schedule a time for further conversation with an advisor. If you look at the episode description, you’ll see a link to schedule a call at a time this least invasive for you. And even if now’s not the right time for us to work together, we’ll point you toward resources to help you in your financial journey. We always look forward to connecting with our listeners, and we look forward to talking with you soon. Welcome back to

Cory 19:59

your business. This your wealth and our asset class investing series. So, to wrap up the episode, the first question we want to answer is, okay, if I’m not going to pick a 15, if I’m going to build a strategy around a 30 year and harness the difference in that cash flow, what should I do with it? And you have two main solutions, because right now, savings accounts CDs aren’t really paying enough to be able to rely on outperforming that mortgage predictably. So the first solution that you could use simplest one is some kind of investment portfolio. Now, we have a very long time horizon 15 to 30 years, so you could be fairly aggressive and in a high percentage stock portfolio.

Paul 20:48

We could say six to seven to 8% rate of return depending on how risky you want to be in what your tax bracket is, and all those those kind of considerations and if I may, I gotta jump on. That idea of well, if you’re aggressive, you could have more in equities. Remember, the person has a 30 year mortgage is putting aside $1,000 less a month toward their mortgage. So they have found cash flow that can effectively be deployed anywhere else. Even if the market five years in takes a 20% dip. The person who just encountered the 20% dip has far more access to capital because it’s at least ended account even at a 20% downturn that they can access in an emergency that is totally not present for the person that did the 15 year mortgage. The 15 year mortgage is couched as the quote unquote safe or quote unquote responsible thing to do, when in fact, it’s just a way for us to make a bigger commitment on a consistent ongoing basis to a financial institution, that if we later asked to have some of those extra payments given back to us, the extra thousand dollars a month that perhaps we put in for the last 10 years and then we haven’t learned To see child who has an enormous health problem that needs medication, or we have a reason that we need to infuse capital into our business, maybe to save the biggest item on your balance sheet. And you go to the bank and say, Can I get that hundred and $20,000 that I gave you extra over the last 10 years? Or Could I just not make payments for a little while based upon all that extra money I gave you? And they’re gonna say, Sure, you have 90 days, and then you’re going to be on the courthouse steps after that. No offense, we’ve loved having you as a customer until now.

Cory 22:30

So we’re five years into a 15 year mortgage, lose your job, and try to refinance into the 30 year mortgage that you would have had before. You can’t say Oh, just give me the same. I just I just want a lower payment. 50. Like No, you can’t qualify for a new one at that point. So you absolutely right. risk. We got to compare all apples and apples.

Unknown Speaker 22:55

Yes, you’re right. That’s right.

Cory 22:58

But But by the same token, because Interest rates are so low. If you’re you don’t have to hit a high bar of rate of return to have an investment portfolio workout. Well, so yes, you could go very, very concerned from the start, or you could be in a higher stock percentage and just say, I know it might dip lower, but over time it it has a low, long ways to dip until I’m really not outperforming my, my mortgage.

Paul 23:26

Well, what’s our second? I was gonna say and the this is something that we’re only going to be able to talk about briefly today. But I promise there’s going to be an episode that covers this down the road in this asset class series, but think about what life would look like, if what happened is the day that they got their 30 year mortgage, remember, they were totally okay with the cash flow requirements of a 15 year mortgage. That what they would do instead is just take $1,000 a month and put that into To a life insurance policy that is funded right against that IRS tephra Tamra corridor so that they have access to capital in an account that has guarantees that has a liquidity profile where we can tap the money if we need to. In this is what we will test when we do a full episode on it. But what I want you to consider is if on day one, when we got a mortgage, we took the difference between a 15 and 30 year mortgage and let’s just say the breadwinner in this household is a 40 year old woman who is the one crushing it much like my mom was the primary breadwinner my whole time growing up. That what she then does is purchases a whole life insurance contract that is heavily over funded for $400,000 of death benefit. Well, now what have we done? What I’m gonna contend is we paid off the house today. You Cuz even if the house is paid off, we’re still going to save that 20 $700 a month somewhere. So if what’s happening is we’re paying what is the 30 year mortgage plus $1,000 a month is going to a tool that guarantees there’s wealth created in the future that can pay off the mortgage, if the primary breadwinner were permanently disabled, if the primary breadwinner, were to die, and Cory and I even did the math, and somewhere around your month, not a month, 16 and a half years 16 and a half, that policy has enough cash value that you could just write a check and pay off the mortgage if you so chose. Now, you may have

Cory 25:36

slightly longer than 15 years, but you’re also doing double or triple duty with that money. It’s accomplishing a few different things. So it’s pulling some weight. I think that little extra tagline probably works out well. And by the way, three years into your 15 year mortgage, the primary breadwinner dies, how much slack does the bank cut you? That’s right, exactly. 00.

Paul 25:56

So Cory, tell us why this is the trick question.

Cory 26:01

Okay, so the trick question, is the bank asking you when you walk in the door? Do you want a 15 year or 30 year mortgage? That quiet? It’s a trick question. Because to think that you actually have to answer it then. Because we’re not telling you to have a 30 year or a 15 year mortgage. we’re suggesting that you can pick a 30 year mortgage with a bank, but you’re not really answering their question. You’re just building a strategy around however you want to pay off the mortgage and whatever timeframe works for you and reserving the right to change that strategy. In the future, should you find a different opportunity or a better opportunity that fits the future that you want for your family better?

Paul 26:46

So when somebody says, Do you want to go with a 15 or 30 year mortgage? What you should perhaps consider saying instead is, well, I’m okay with paying the cash flow of a 15 year mortgage, but I’d also like to have access to my capital when I need it for the sake of investment or emergency I’d also like to make sure that I have the best possible opportunity to keep my home. If my income is interrupted due to sickness or injury, I would also like to make sure that I’m able to achieve market rates of return rather than, as I pay off this mortgage early, I am relegating my money to only avoiding an interest cost of 3%. That could be tax deductible depending on tax laws like that. You can have all of it we’ve got to get out of the micro mindset that the financial institutions teach us to be in that each tool we get just as one thing and instead, think about maximization, optimization, and orchestration of all the assets that you have. You see, we we know there’s many people, many of you listening out there that we may never get a chance to have a conversation with. But we do look forward to having that conversation one day. But if you’re taking on these questions you’re taking on this new knowledge. We hope that it’s really driving new conversations with you and the institutions with which you interact and we want to hear about that. Now of course, you can always email us at info at SF GW a.com. Find us at ask wealth podcast on a bunch of the social media LinkedIn. But here’s what we need you to do. Just go online and do a review on iTunes. Just go to YouTube and subscribe. Because as those channels get amplified as you share an episode or two, on your social media, we are learning from more and more people all the time that they found our podcast because somebody shared it, and they ultimately became a client, we were able to make a tremendous difference in their life. And I love that. But that’s not the most important part. The most important part is that you’re listening right now. And you got to hold this podcast from somewhere and you doing your review, make sure that somebody else has the best opportunity to expose to the same knowledge you’re now being exposed to. And to help you in that. Here’s what we’re willing to do for anybody. That do that review just do the review, send it to us on any of our social or info at SF g isn’t sound finance group wha like washington.com sf TWA comm send that to us a screenshot with your home address, we’ll send you a copy of our most recent book, sound financial advice. And then when our next book releases later this year called your business, your wealth, we will also send you a copy of it. So we just want to encourage all of you get on there, do the reviews, share this episode on your social media, because we know and what we’re after is that this makes a difference in your future. It has an opportunity to make a difference for them. And as always, we hope that this episodes contributed to you being able to design and build a good life.

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