Never Prepay a Mortgage - Posted by Sean

Posted by Sean on March 31, 1999 at 13:57:46:

I’m not going to come out and say that all other things equal that having higher debt doesn’t create more risk. I’m just pointing out that it’s pretty rare that all other things stay equal.

I think we can all agree that someone who receives $1,000,000 a month and pays out $900,000 a month is in a more precarious position when compared with someone who brings in $200,000 a month and pays out $100,000.

I feel that a person’s risk in regards to debt has a lot to do with the repayment terms, the person’s cash reserves and other factors far more than the actual amount of the debt. I don’t like seeing knee-jerk responses to a complicated situation where a cost-benefit analysis would be much more appropriate.

Never Prepay a Mortgage - Posted by Sean

Posted by Sean on March 23, 1999 at 11:33:54:

Ok, some of you will remember a thread in here where we argued back and forth about whether it was ok to prepay a mortgage or not.

I wanted to say that I’ve backed down from my original NEVER, NEVER, NEVER stance to say that I consider it somewhat acceptable to prepay adjustable rate mortgages because when you prepay and your payment gets refigured your acceleration results in a lower payment.

Although it’s still not likely to be a good idea, and I recommend that anyone who disagrees with me reads before they post a response. Thanks, and remember to STAY LIQUID!

On the subject to Robert K… - Posted by Carol

Posted by Carol on March 25, 1999 at 07:00:20:

His point was

  1. to understand the difference between assets and liabilities
  2. use the income from your ASSETS to purchase things such as ‘liabilities’ like a house, not first to go after the home.

So, the logical thing would be to have your assets pay for it, as in the example of selling off acreage.

I had a short chat with him on the subject to personal homes. My take was that, once you have the proper understanding, he doesn’t ‘care’ what you do … just don’t fool yourself in doing it!

Never Buy the home that you are living in! - Posted by Mark R in KCMO

Posted by Mark R in KCMO on March 24, 1999 at 16:10:59:


Why would ANYONE ever want to buy the home that they are living in?

It is NOT an investment only an expense.
Your illustration you points out the benefits of paying interest, that leads to the question…
Why would anyone want thier payment to be anything OTHER than interest? Why pay on principal at all?

I know that there are lots of realtors and banker out there that say your home is your biggest investment but they are WRONG! it’s an expense!

BUY assets LEASE liabilities!

Your corporation should provide housing for you.

Anyone who owns thier own home doesn’t understand the basic concepts of control don’t own.

This is a free country, you can do what you want, you can choose to be a part of poor and middle class if you want to.

There is nothing wrong with doing that as long as you know that is what you are doing.

Sorry Kiyosaki changed my view on nearly everything. Many things that made sense to me prior to the convention, no longer seem reasonable.

You simply acknowledge that your home is an expense.

It isn’t worth much time or effort to manage this expense.

Focus on assets, cash flow, minding your business.

Don’t step over Dollars to pick up pennies.

Hope this helps

Mark R in KCMO

Re: Never Prepay a Mortgage - Posted by JPiper

Posted by JPiper on March 24, 1999 at 13:37:49:


You seem to be on a one-man mission to convince people they should NEVER prepay a mortgage. It is somewhat gratifying to see that you moved a baby step up the learning curve and reduced the number of “NEVER’s” that you’re using concerning this issue. In any case, Citicorp is quite gratified with your continuing mission?..they need another crystal chandelier in the lobby.

I was struck by the conflict in your statements. On the one hand you recommend never prepaying because it reduces liquidity and return. On the other hand, in order to get this higher return you have to reduce liquidity. You have to take that cash that you didn’t prepay with and invest it in other ways, ways that will reduce liquidity. I think we both know that “stay liquid” is NOT your advice?.in fact, your advice is anything but that. Your advice should have been “keep the pedal to the metal”.

Everyone here knows that maximum leverage accelerates return?.this is a rather elementary concept. You can figure it all out on a spreadsheet or with a calculator. Those that are persuaded by just numbers will be fascinated with the “pedal to the metal” concept?.just as you are.

What a calculator or spreadsheet won’t show however is the question of risk. In other words, higher rates of return can ONLY be attained by accepting higher levels of risk. To illustrate this point, imagine a guy with 10 free and clear properties. If all 10 tenants don’t pay one month, he doesn’t make any money, but he doesn’t spend any either. On the other hand, imagine a guy with the same 10 properties, each with mortgage payments of $500 per month. All 10 tenants don’t pay one month?.but this owner has to write a check out to the mortgage companies of $5000. Admittedly, this is in all likelihood an exaggerated example. I have only used it to illustrate the fact that leverage carries a risk.

Risk is not a subject that most young investors are particularly concerned with. Their focus is strictly on return?.and perhaps appropriately so given their age and ability to recover if they fail. But risk is a subject that anyone with a measure of experience WILL focus on?.because they have seen the consequences of leverage.

Is it possible to mitigate against the risks of leverage? Yes it is. But it takes a recognition of risk before you can mitigate against it. One thing I can assure you of is that your argument has been made for years. It’s nothing new. And it’s an easy argument to make because the numbers from the return side of the equation support it. Just understand that high leverage equals higher risk.

Saying that you would NEVER prepay a mortgage may be appropriate advice for you Sean. Owning a free and clear property may be repugnant to you. But it’s not appropriate advice for everyone.


From one who “almost lost it all” - Posted by Laure

Posted by Laure on March 24, 1999 at 09:11:49:

Several years ago, I was in a business that was HOT HOT HOT. I borrowed a butt load of money to buy equipment to open stores, and did very well. The business operated for 17 years and was extremely profitable. I bought all kinds of “doo dads” and was quite proud of myself. I also invested in real estate until it hurt ! In the later years, the business encountered much competition. For the first 6 years, I was almost the only show in town. Now I have more competitors than I can count. During the hay days, I did accellerate my bank loans… and Thank God I did !
I was hit with a huge tax audit in the mid 90’s. If I hadn’t pre paid mortgages and business loans, I wouldn’t be in business today. That is just a fact.
I agree that you cannot expand and grow your net worth without adding debt, but keep it in control.

Laure :slight_smile:

Present Value Game - Posted by JHyre in Ohio

Posted by JHyre in Ohio on March 24, 1999 at 04:44:48:

If the asset purchased with the loan throws off substantially greater income than the loan costs on an after-tax basis, I would keep the loan. Chances are I’ll never prepay on my mortgage because I could never again find money that cheaply!

John Hyre

Re: Never Prepay a Mortgage - Posted by LC

Posted by LC on March 23, 1999 at 20:52:59:

One thing that I get a chuckle at when discussing this matter is the argument that you lose a valuable tax deduction. How valuable is it to get back $0.28 for every $1.00 you spend?

Re: Never Prepay a Mortgage (long) - Posted by Rob FL

Posted by Rob FL on March 23, 1999 at 20:24:06:

I have thought about your original post of several weeks (or months) back many times since then. As a matter of fact I was thinking about it yesterday.

I agree that many times the extra principal payment could be applied to other investments to increase your rate of return.

I also agree to stay liquid. Not to keep all your assets liquid, but to have at least 12 to 18 months worth of money liquid that could pay your basic monthly expenses. I don’t believe in having hundreds of thousands liquid unless you are a millionaire and it is a small % of your net worth.

I do feel that personal debt should be minimized. If a tenant is paying off your mortgage, that is one thing. But if the money to pay it off is coming out of your pocket, that is another. If you have no personal debt, and you get laid off or get in an accident and don’t have income for a few months, you won’t be in nearly the financial havoc as you would if you had a $900 a month mortgage payment that couldn’t be paid for 3 months. I think Cashflow Quadrant sums it up pretty well about not taking on debt unless it is being paid off by other people.

As for the article you listed, I think it is very true. And not to offend its author or anyone else, but I think it neglected one point. When you sell the $119,000 mutual fund you will have to pay a capital gains tax of 20% or more. So the whole $119,000 is not yours, you lose $20,000 or more in taxes. Just a thought to take home with you.

Also, as for interest being tax deductible, I look at it this way. Say I am in a 28% tax bracket (normal middle-class American). I pay $10,000 a year in interest. But my tax write-off is 28% or $2,800. So in reality I only spent $10,000-2,800 = $7,200. Now lets see, if I have the mortgage I lose $7,200 a year (gone forever) in my interest payments. If I don’t have the mortgage I don’t get a tax write-off, but I lose zero, nothing, nada except maybe some opportunity cost for paying it off early. But $7,200 now in hand is worth much more than money down the road relying on the stock market. (which by the way crashed 218 points today).

You make some valid points and you did before in the past. This is an interesting discussion.

Limited Agreement - Posted by Sean

Posted by Sean on March 25, 1999 at 15:38:19:

Only to a limited extent would I agree with your post. Yes, paying extra principal is generally not a wise financial decision. Logic then leads us to the conclusion that paying interest only seems better than a 30-year amortized loan.

Taking this to the logical conclusion we surmise that negative amortization is the best of all. That’s why I recommend that people seek GPM (graduated premium mortgages) wherever it makes good business sense. Most GPM mortgages have initial payments quite low and increasing at 7.5% a year. Initially you will have negative amortization for the first 5 years and complete payoff in 30 years. Just refinance when the payments start to get out of hand. I would only caution people that GPM’s cost more points and that needs to be factored in to any financial analysis. I read a great article today on GPM mortgages and can you believe I can’t find that web page anymore?

I agree that owning a house results in a loss. That is, you must pay out of your pocket every month for maintenance, insurance, tax, mortgages, etc. However it is deceptive to say it’s not a business. You don’t have to write out multiple checks to yourself to mentally consider it a business. In essence you are owning a rental property that you are renting. You don’t need to have a corporation hold title or anything to make the mental adjustment of having yourself as a tenant.

Plus you, as a tenant, have many advantages. You’ll never move out and leave the place vacant, or trash the place or stop paying your imaginary “rent.” You are your own perfect tenant.

On the other hand, I see a lot of people who make good business decisions every day go loony when it comes to buying a house. It’s true that a house CAN be a good investment, but too many people buy a house with their heart and not with their head. They see the “perfect” house that they can imagine their furniture in and they buy it regardless of whether it makes financial sense.

Then a few years down the road they’ve fallen out of love with the house and find that they can’t rent it for enough to cover the payment and are surly about it. That’s what results from making important decisions based on emotions, not good sound thinking.

For a complete explaination Please read!! - Posted by Mark R in KCMO

Posted by Mark R in KCMO on March 25, 1999 at 11:57:08:

Hey Group

It was a contrast to what the other post said. if you don’t want to pay down your debt, it must be a good idea to never pay principal, or better yet or just rent.

In Dallas Kiyosaki was questioned is it was a good idea to move every 2 1/2 years to capture the cap gains “profits”.

His response was it was too pedestrian, to waste time on your house, it’s an expense just accept it and focus on your business.

This is the way I concluded my message.

You simply acknowledge that your home is an expense.

It isn’t worth much time or effort to manage this expense.

Focus on assets, cash flow, minding your business.

Don’t step over Dollars to pick up pennies.

Mark R in KCMO

Financing and Leasing are the Same Thing - Posted by JHyre in Ohio

Posted by JHyre in Ohio on March 25, 1999 at 08:37:07:

Kiyosaki is right- a house is a liability. So is rent. You gotta have a place to live, so you WILL incur a liability. The only question is which liability costs less. In my experience, leases are more expensive than debt financing 95% of the time. The payments/rate on the lease are almost invariably higher, the transaction costs of initial set-up are usually MUCH higher and you have no chance of gaining appreciation- unless you have a very low priced option to buy. But if you have that, the lease IS conventional financing for all intents and purposes. In fact, the government will treat such a lease AS financing.

The only question is: how to minimize the impact of the liability. The odds are against you with a lease. Even if you can invest any difference at a very high rate, you can get a low rate home equity loan (additional liability) on owned property & invest THAT at very high rate.

John Hyre

How 'bout this…? - Posted by raelynn mitchell

Posted by raelynn mitchell on March 25, 1999 at 01:16:14:

What if you figured out the amount of $$$ you needed to live on to cover house note, food, and minimum expenses, and then decided to add 20% to this amount and make sure your corporation paid you only this amount? House note is deductible to you; a major deduction that roughly equals your income. All other expenses get paid for with pre-tax dollars, thru the C Corporation. That way, there is very little non-deductible income; your income equals your write-off base.

The minute they decide to change the deductibility of mortgage interest this all changes, you know. Especially now, since you can buy a house and then sell it once every 2 years and not be taxed on the first $500,000 in profit as long as you buy a replacement home.

Re: Never Buy the home that you are living in! - Posted by Rob FL

Posted by Rob FL on March 24, 1999 at 20:57:38:

Why would you want to rent a home from your corporation? It doesn’t make sense to me. You lose so many of the benefits that the law allows by doing this.

You lose an income tax deduction for mortgage interest, RE taxes, and up to 500K in capital gains for a married couple.

You lose a homestead exemption off of your property taxes (at least in FL they knock 25,000 of the asessed value from what you owe in taxes). About $500 a year for me.

You lose homestead protection from your creditors. Most states have a dollar limit like the first $100,000 in equity. In FL it is an unlimited dollar amount for homestead. It is exempt from unsecured creditors in FL, period, even in a bankruptcy.

You cannot get homeowner’s insurance. You would have to buy a corporate landlord policy and then renters’ insurance. You will more than likely end up paying an additional 50 to 100% more in insurance than just a plain old homeowners policy.

Please explain what you are trying to say. It sounds like from what you are saying that you plan on renting a home forever and advise everyone else to do the same. In the Cashflow Quadrant, Kiyosaki gives a creative idea of owning his house free and clear by selling off a large portion of acreage and carrying back a mortgage. That sounds completely the opposite of what you just said.???

Let’s Put a Pencil To It… - Posted by JPiper

Posted by JPiper on March 24, 1999 at 20:26:23:

Let’s put a pencil to your statements and see if they fly.

Let’s assume a new homeowner and a renter?both with $10K. The homeowner decides to buy a $100K house. He uses his $10K as a downpayment, and finances the $90K at 7% interest for 30 years. His payment is approximately $700 PITI. The renter on the other hand leases for about $1000 per month. On the surface of it the homeowner is $300 better off. But wait, the homeowner also gets a tax deduction. Let’s say that is approximately $200. So where we stand at this point is that after tax the homeowner is paying $500 net?.the renter is paying $1000?.a difference in favor of the homeowner of $500 per month, or $6000 per year.

The renter however is no dummy. He is a knowledgeable investor. He takes his $10K and looks for an investment that will get him even with the homeowner. It’s no easy task, because he has to find an investment that will consistently give him an after tax return of $6000 per year. Hmmmmm. If he’s in the 30% tax bracket, he will need to earn 85% pre-tax approximately to net him the $6K.

But let’s not stop here. Each year the rent goes up, thereby increasing the hurdle that the renter has to meet in his investments JUST TO EQUAL the homeowner.

Now what we didn’t take into account here are the repairs that the homeowner will be required to make over time. We also didn’t take into account the appreciation that the homeowner will likely experience over time, nor the fact that if the homeowner sells and his profit is less than $500K this will be a tax-free sale. If appreciation equals 4% per year, my guess is this is going to be more than sufficient to handle repairs as the arise. We also didn’t account for the equity build-up from the monthly paydown on the loan?which in 30 years leads to a free and clear house. Now figure out what the renter will have to be earning on his investments in 30 years.

Perhaps you meant that a corporation should buy your house and you rent it back. This doesn’t appear to be much of a move to me?.in light of the fact that the corporation would lose the tax advantage that a personal residence currently has. You could certainly turn the corporations purchase of a house into an investment for the corporation?.but I think a careful analysis would lead you to the conclusion that you’re mostly shifting dollars from one pocket to another?.and creating other problems as you go.

A more rhetorical argument might be that if leasing is the way to go then we should see some examples of this somewhere in our society?..some extremely wealthy renters. But rather than this if we analyze the records what you’ll find is that the renters as a class tend to be the poorest members of society, and the homeowners the wealthiest. Matter of fact, high priced real estate is typically sold for cash?no loan involved.

Finally, I wondered about your statement about “why would anyone want their payment to be anything other than interest?”. One reason might be that eventually the lender wants their money paid back?one way or the other. But if you happen to find someone that loans money on a permanent, interest only basis please let me know.

By the way, I handle this the other way around than your suggestion. I own my house, in which I rent space to my corporation. This enables me to pay money out of the corporation without self-employment tax. It also enables me to depreciate a portion of my house, and deduct certain other expenses.


Bad example/improved example (long) - Posted by Sean

Posted by Sean on March 25, 1999 at 16:16:19:

Well, your risk scenario is a little off, don’t you think?? But let’s examine your scenario with a little more realism. You suggested as the model person someone who owns 10 properties free and clear.

Let’s assume, for the sake of simplicity, that all properties are worth $100,000 rent for $1,000 a month and have a net operating income of $10,000 a year. Let us also assume that your model person has $1,000,000 cash and wants to invest it in real estate. He purchases all 10 properties outright for $100,000 each.

Now let’s consider my “improved” person (not ideal, because ideal would indicate buying the property for no money down or possibly less than no money down). He also has $1,000,000 cash and decides to invest in real estate. He chooses to place 20% down on $100,000 properties that are exactly identical to the above properties purchased by person A. We can see that person B will soon own 50 properties 80 percent leveraged. We assume that closing costs for both parties are paid for by the Seller via a 3% credit. Person B gets an 8.5 percent interest rate, seller financing, interest only.

We will now consider three seperate months in which various things happen to determine who has made the better choice.

Month 1: Everyone pays, 10% vacancy - advantage person B

Person A receives $9,000 in rent and pays $666.67 in maintenance this month. He nets $8,333.33 for this month.

Person B receives $45,000 in rent and pays $3,333.33 in expenses. He also pays $28,333.33 in mortgage payments and nets $13,333.34 this month.

Month 2: 9 Units Refuse to Pay (10% vacancy)

No one pays person A this month. He suffers a loss of $666.67 this month.

Person B receives rent from 36 units this month (5 vacant, 9 won’t pay) for $36,000 income. He must pay $3,333.33 in maintenance and $28,333.33 in mortgages and still profits $4,333.34 this month.

Month 3: 40% vacancy/non-payment

Person A receives rent from 6 units at $1,000 each. That’s $6,000 and still pays $666.67 in maintenance for a gain of $5,333.33.

Person B receives rent on 30 units at 1,000 each for $30,000 income. He then pays $3,333.33 for maintenance and $28,333.33 in mortgages for a loss of $1,666.66.

Three month total Person A: $12,999.99 gain.
Three month total Person B: $16,000.02 gain.

Person A rate of return: 5.2%
Person B rate of return: 6.4%

Basically, even with bad luck, person B’s choices are totally kicking person A’s choices butt. Person A is the one with more risk, because he owns less units!

I am not impressed with your reasoning or your examples at all! You’re going to have to do better than that.

Whoo boy! - Posted by Redline

Posted by Redline on March 24, 1999 at 15:17:35:

Piper - “crystal chandellier”?? Yeah I think I saw them putting that new one in today on 5th avenue in Manhattan . LOL you crack me up!!

Anyway, Sean - I agree with Piper on this one. Your numbers make sense and you can talk about it until you’re blue in the face - but you know what? I prepay my mortgage and I will continue to prepay ALL my mortgages from here on in.

I will get them paid off early and feel warm and fuzzy about it when all the $$ coming in is GRAVY. Now, I did NOT say that ALL my excess cash goes into my mortgages did I? Nope. I also invest my share into the market and will continue to do so.

So I have the best of both worlds, no? I have “liquid” money in the market which I can sell to have cash and I have my mortgages getting paid off quick.

I like my future odds.


Re: Never Prepay a Mortgage - Posted by Sean

Posted by Sean on March 24, 1999 at 12:23:28:

Well, it is relevant. For example suppose a guy has a 7 percent mortgage and he decides to pay an additional $100.00 in principal every month, while his friend also has a 7 percent mortgage but decides to pay $100.00 a month into an investment that will pay 7 percent interest.

At the end of 5 years the first guy has saved $7,159.29 and the second guy has earned $7,159.29. The second guy then sells his mutual fund and gets hit with a 20 percent capital gains tax and ends up with $5,727.43 cash. The other guy has lost $7,159.29 in tax deductions and is in a 28% tax bracket so he has lost $2,004.60 in tax deductions leaving him with a net gain of $5,154.69.

So, basically, even at the same interest rate you’ll do $572.74 better by investing in a mutual fund than by prepaying a mortgage. Plus you have the advantage of having an emergency source of ready cash.

Plus we should be able to do substantially better than 7 percent return on an investment. How much yield do people claim to get on mobile home investing or buying real estate notes? More than 7 percent, that’s for sure.

Re: Never Prepay a Mortgage - Posted by Reif

Posted by Reif on March 24, 1999 at 09:28:58:

>>How valuable is it to get back $0.28 for every $1.00 you spend?<<

While this is true of most things, there is another consideration.

Assuming you HAVE to have a roof over your head, if you can pay the same for a mortgage that you can for rent, I think it makes way more sense to do so, especially for the long term.

However, if you are single, I think it makes way more sense to get a couple of roommates, rent a three or four bedroom place, and reduce your cash (out) flow.

Also, as someone else mentioned, the mortgage tax deduction for the lower income folks is not that great because the standard deduction is almost as high as some of the mortgage deductions on the lower priced homes.


Re: Never Prepay a Mortgage (long) - Posted by John Katitus

Posted by John Katitus on March 24, 1999 at 02:29:45:

Just a quick comment that probably doesn’t apply to you guys, anyway, but here goes:

You only save on interest deductions as they, when added to other itemized deductions, exceed your standard deduction. If other deductions were very low, you could eat up a lot of the savings getting up to the standard deduction. Just a thought. John