Proof that any idiot can write a book!

[Chance the Gardener]

Hard to believe that anyone can preach the virtues of interest-only ARMS and call the 30-year fixed “the single worst mortgage in creation.” This UT article is evidence of the end… the authors are playing a familiar tune on the deck of the Titanic.

http://www.signonsandiego.com/uniontrib/20070225/news_1h25brubook.html

[Anonymous]

The advice in the book is quite sensible, IMO. First, the fact that you are owning rather than renting normally means that you are risk-tolerant and desirous of increasing your wealth. Not everyone is in this position. For example, elderly people who can no longer maintain a house would be better advised to sell, rent, and put their money into CDs or government bonds.

Now, given that homeowners are risk-tolerant and desirous of building wealth, the best way to do that is with leverage. Obviously, you only want to use leverage when you can earn more than you are paying in interest on the money you borrow. But given that you can find an investment opportunity which pays you more than you pay the bank for your mortgage, especially after taking into account income tax deductibility of mortgage interest, it makes sense to avoid paying off your mortgage.

Note the authors do not recommend borrowing 100%, because then you have to pay PMI. Rather they recommend putting 20% down and then refinancing now and then to maintain the equity at no greater than 20%.

Also, there is nothing wrong with ARMs. Because fixed rate mortgages can be refinanced whenever interest rates drop, the bank has to compensate for this. The result is that borrowers with fixed rates pay more than borrowers with ATMs, in the long run. Obviously, you have to forward looking with ARMs, and prepare for possible increases.

The rules this book advises are the same as those followed by professional real-estate investors.

The one caution I would make is that these rules are not for undisciplined spendthrifts. For these people, paying off the mortgage acts as a form of enforced savings. I’m assuming the readers of this blog are more disciplined/sophisticated than that.

[Chance the Gardener]

Sensible?

The book was written in 2007 when not even the most zealous optimist is willing to say that real estate will appreciate in the short term. The authors advise you to leverage your money so that you can invest in a stagnant or falling asset?

Furthermore, there is little hope that interest rates will do anything but go up in the near term. Certainly, if you can make more on the bank’s money than your after-tax cost of borrowing it then paying off your mortgage early doesn’t make sense. I just don’t see how that can be done in this RE climate.

In this market, not borrowing at all seems to make the most sense. Why not rent and invest the money you save not paying interest, taxes and HOA’s. Hopefully the recent tightening in lending practices will prevent the “undisciplined spendthrifts” from attempting to implement the author’s dubious advice.

[Anonymous]

>>Furthermore, there is little hope that interest rates will do anything but go up in the near term.

I see you are smarter than the collective intelligence of Wall Street and the rest of the investment world, which is pretty certain than interest rates are NOT going up anytime soon, which is why the rate in 30 year bonds is LOWER than the overnight rate. With this ability to outsmart the rest of the investing world, you will soon be a billionaire via shorting long-term zero-coupon treasuries.

>Certainly, if you can make more on the bank’s money than your after-tax cost of borrowing it then paying off your mortgage early doesn’t make sense. I just don’t see how that can be done in this RE climate.

Very easy. Plenty of cash-flowing properties in Texas, Michigan, upstate New York, just to cite a few examples. I won’t say it’s easy work. Broken down houses that need rehabbing in crummy neighborhoods with troublesome tenants. Been there, done that, don’t want to do it again. But for some enterprising young person who wants to make their fortune, there gold in this sort of thing. There is no housing bubble in most of the country.

Now I admit, the book is taking advantage of the current real-estate mania and most people are not cut out to be part-time RE investors. In fact, many people are not cut out to be owners of real-estate period. But for a significant fraction of the population, part-time and eventually full-time landlording is and always has been the easiest way to get rich in this country, precisely because of the possibilities of leverage. There is another group of people who are cut out to run other types of businesses than real-estate, and for these people, it makes sense to borrow money using a home mortgage, at a low rate, rather than trying to get a bank business loan at much higher rate.

[Doofrat]

This is one of the good/bad things about the Internet. When you write something like that, it will linger forever in “cyberspace” and you will either look like a complete idiot, or a genius in the future.

[no_such_reality]

The advice in the book is quite sensible, IMO.

They always lose me at ‘cheap’ interest only loans.

Spot checking bankrate: the four ‘cheapest’ no points I/Os are 30 years at 5.936%-6.058%. Shorter time frame is worse.

30 year fixed is 5.529%-5.550%.

The I/O payment on $400K loan would be $1978.67 – $2019.33
The fixed payment is $2278 – $2283. However the interest portion maxes at $1833.

So in exchange for parking a $430+ of your money in your equity, you pay an extra $150 in interest and invest $300?

Somehow I don’t think 5%, 10% or even 15% interest is going to make up my extra interest expense.

[garysears]

I’m not an investment expert, nor do I own any property. However, I do see how leverage is the way to build wealth quickly and how this book makes sense in some cases. Actually, this is probably how many many wealthy people got that way.

It’s all about the CASH FLOW. I can see how maximimizing the flow maximizes the leverage. The main point is the property MUST cash flow to cover whatever carrying costs you have. Otherwise there is no extra money to leverage.

The other main point is we are not considering a single property. If you are only buying 1 property you might as well pay off the debt if the property isn’t appreciating quickly. However, the goal is to buy more and more and more properties.

I don’t see how cash flowing opportunities could be currently possible for new investors at today’s prices for SFR properties in SOCAL. It IS possible for some types of properties in other areas though. The day when residential properties in SOCAL can cashflow for wealth building investors (after a 20 percent down payment), the market will probably be “back to fundamentals”. I’m sure this had to have been the case at one time even in SOCAL. Otherwise we are all indeed too late and permanently missed the gravy train.

I think it is a matter of perspective and goals whether you are “saving” more money by building equity by paying off a loan or “wasting” money by only making interest payments and investing the difference.

I think the reality is the “interest only” investor will not have a high interest paying investment that makes up the difference “lost” to the “loan payoff” investor. However, that “reduced” amount of money saved is not locked up in the mortgage. The goal is to save money until an additional 20 percent down payment can be made to purchase another leveraged cash flowing property. Once the $300 dollars you invest every month adds up with interest to make 20 percent for a new property, you buy it. Now those 2 properties are working together providing more cash flow than the one property. And now 2 properties are appreciating (someday again) with leverage vice one.

If you choose to pay down the loan, that $410 you “saved” every month is still locked up in equity. Granted, you can always cash out refinance, but that would be defeating the point. We are talking about a difference in goals. Some people want to be debt free. Others want to be wealthy. If your property doesn’t cash flow in SOCAL and you can’t get a higher rate of return elsewhere than your mortgage rate, paying off the loan is probably the way to go.

So it does make sense to me to never build equity with payments, but to build cash flow, and let equity build over time with appreciation.

That being said I’m emotionally solidly in the “debt free living” camp when it comes to my eventual home purchase one day. I would view my own home as shelter vice an investment. A poor decision? Perhaps. I haven’t ruled out leveraged wealth building through real estate. Those opportunities will have to get eashier to find though.

I’m still working on that first down payment.

[PerryChase]

I’m a big believer in keeping business and personal matters separate.

It’s best to have a steady a source of income to pay down your house loan and meet your daily expenses and save for your future needs. Eventually you want to pay-off your house. Keep a slush fund for emergencies.

In the mean time, you can invest all you want with the extra cash but don’t gamble with your personal residence or your family’s well-being.

Business deals have inherent risks — that’s why it’s business. I’ve seen people ruin their lives, relationships and marriage because they mixed the two.

Think of the people who “invested” in California real estate recently. If you’re 50 years old and put everything into flipping properties in Carmel Valley, a big crash may cause a divorce, soured relationships with friends and family and potentially an early lonely death from stress — some people may say a well-deserved one.

[no_such_reality]

The goal is to save money until an additional 20 percent down payment can be made to purchase another leveraged cash flowing property.

In my previous example, a $100,000 down payment would be required on a $500K home. The mortgage would be based on a $400,000 loan.

At 10% earned interest compounded monthly, the IO loan investing the difference in payments takes 172 months (just over 14 years) to make the down payment.

The principle payment obtains 40% equity in 158 months, 13.16 years.

As long as housing isn’t depreciating, fixed principle payment will compile the necessary down payment faster.

[surveyor]

re investing

I read the article, I personally didn’t see anything wrong with the advice given in the book. In fact, the math does work out regarding not paying your mortgage early or minimizing your principal payments.

When you are aggressively leveraging to invest in real estate, it is not very useful to make principal payments because you will tend to refi that money back out anyways every two years (in a hot real estate market, you usually have to do it every year).

Is it risky? Heck yes.

Still, you got to make sure the real estate you are buying is going to work out, math-wise. With that in mind, no properties in San Diego will work out.

There are specific instances when to use IO loans and when to use fixed loans in real estate investing.

For appreciating markets, where you will have to refi money out frequently, interest only loans are useful.

For depreciating markets, fixed rate loans are advisable, because you don’t know when the market will start appreciating and you will have to refi/re-leverage money out again.

[garysears]

no_such_reality,

Based on what you presented, it does sound like the long term fixed rate interest only loans come at a premium that doesn’t make sense for normal investment returns. Of course there is always a higher rate where you break even. The question becomes: what is a reasonable expectation for an investment return over time?

What about ARMs? Can you see any case where getting an ARM might make sense? The problem is you have to be able to predict future rates with an ARM to see what your break even point is.

I know the rationale is that if the rates now are at historic lows, then the common man would predict it to be likely for rates to correct back higher towards more “normal” historic rates. That is especially true over the time frame we are talking about.

But then again, I realize that I am not as motivated or educated or experienced as the many wealthy investors who prefer ARMs as an “investment tool” and devote their time to figuring out how best to accumulate wealth.

The common man inside me screams that ARMs only make sense in an environment of lowering interest rates. Yes, the fixed rate loans come at a premium because you are paying the bank to assume the interest rate risk. I suspect the “knowledgable” investors who use ARMs probably take them with more indepth knowledge of the broader economy that allows them to feel comfortable taking on the interst rate risk personally.

I applied the “common man” theory to San Diego real estate back in 2003 when I almost bought a condo in Pt Loma. I decided not to gamble and keep renting. I kept thinking that I was likely the bigger sucker who would be left holding the bag, locking in someone else’s real estate winnings. I didn’t want to be the last one looking for a chair when the music stopped. Even though it turns out I would have made some money had I timed it right, I don’t regret it.

My conservative nature will probably keep my from ever doing the interest only or ARM thing. I guess that lack of risk taking will keep me from ever being wealthy as well.

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