If I could share just one real estate tip it would be to pay off your mortgage early. I will show you how by using biweekly payments. It’s a simple and easy trick that your bank doesn’t want you know about and will save you tens of thousands of dollars.
I bought my first home during the peak of the real estate boom thinking I would own it for a few years and make a massive profit because prices were rising dramatically every year. Was I ever wrong. Within 2 years my property value took a downward spiral and to this day I owe way more than what it’s worth. But this doesn’t bother me because I have a long-term plan where my home will make me money every month. Let me show you how.
For those of you who have purchased a home, there was most likely a document you signed called the truth in lending disclosure. It showed how if you made every payment on time for the next 30 years you would pay almost double what you bought it for. That is how bankers calculate compound interest loans. Let me show you a different set of rules that will literally save you tens of thousand of dollars. It’s called biweekly payments, and will help you gain home equity at a rapid rate.
Now the bank’s way of calculating interest is based upon paying the loan payment once a month using compound interest. With a biweekly mortgage payment plan the loan payment is divided into half of the monthly amount paid every 2 weeks. You would make 26 half payments which equal 13 monthly payments. The is the equivalent of making 13 mortgage payments in 1 year instead of 12 and takes a 30 year mortgage pays it off completely in 25 years. Let me show you what this looks like in actual dollars.
As you can see the biweekly payment plan accelerates the principle pay off so the finishes 5 years early and saves $30,000 in interest payments. The key principal is that you pay the same amount every month like a normal mortgage but it’s divide up into two equal payments. Now who wouldn’t want to save that kind of money, gain rapid equity in their home and finish making payments 5 years sooner?
This abbreviated chart below shows principal remaining by year for a $250,000 mortgage at 4% interest.
Year 1 Year 5 Year 10 Year 15 Year 20 Year 25 Year 26 Year 28 Year 30
$245,597 $226,118 $196,959 $161,357 $117,885 $64,808 $52,860 $27,485 $0
$244,342 $219,315 $181,869 $136,171 $80,401 $12,058 $0 $0 $0
Notice how after year 25 the balance is completely paid. In this example it would save $29,000 in interest over the life of the loan.
Standard monthly payment of $1,193 & total interest paid $179,673. Biweekly mortgage payments of $596 & total interest paid $150,450. The biweekly option creates equity faster by paying the principle quicker.
One detail I do want to explain. Not all mortgages have a biweekly option and some charge a service fee. When inquiring make sure you choose the loan accelerating option. If your mortgage doesn’t have a biweekly loan accelerator option you can do this on your own by taking the principal payments you make each month and divide by 12. Add this amount to your mortgage payments every month as additional principal.Notice how after year 25 the balance is completely paid. In this example it would save $30,000 in interest over the life of the loan.
Now most people would say, “I don’t plan on owning the same home for 30 years.” In many cases this is extremely legitimate. Jobs change, families grow or shrink, all kinds of life changes happen, causing Americans move every 5-10 years. But let me show you something first and I’ll use the same data from the figures above. The same home that was mortgaged for $250,000 had a 5% down payment and a purchase of $262,500. If that home appreciated at a modest 1% (Illinois average over last 30 years was 4.8%) 5 years later it would be worth $275,890, after 10 years $289,963, and after 30 years $353,810. If we use an appreciation of 4% that same home would be worth $851,391 in 30 years. Now that’s absolutely amazing.
If you’re satisfied with this one tip then there’s no need to read further. But if you want to know how to build wealth in real estate with no gimmicks, risky schemes, or speculation, just honest hard work and smart decisions, then please read on.
An overwhelming number of Americans are not super rich and made of money, but over time through working a steady job are able to save a little bit of each paycheck. Let me give you an example of how you can leverage your personal savings account, buy another home and “move up.”
When the average American moves in that fifth year, what if they were to rent out their existing home and purchase another? The passive income opportunities could be absolutely astounding in the years to come. I’m going to stick with the figures from above and estimate that same home would rent for about $2000 per month. The table below will explain cash flow per year.
Principal & Interest $1,193
Monthly Rent $2,000
Monthly profit $278
Yearly Profit $3,336
Rate of Return on Down Payment 25%
This table does not take into account lawn care, snow removal, or maintenance fees since these items vary drastically.
Rate of Return:
Yearly Profit divided by initial investment
3336/ 13,125 = 25%
Let’s convert this to investment terms and return on investment (ROI). Let’s remember the initial 5% down payment or $13,125. Divide yearly earnings of $3,336 by $13,125 and your rate of return is 25% per year with your initial investment being paid off in just 4 years. That is outstanding considering only the riskiest stocks pay 15%-18%. Taking this scenario to it’s logical conclusion has the tenants paying off the entire mortgage, after which point $1193 a month is all profit in today’s dollars. This does not account for inflation, rental price increases and tax increases since we have no idea what that would be so far into the future.
So there you are earning $14,000 a year, the home is paid off, and appreciated up to over $850,000. How does that sound? What if you were to do this more than once and purchase one home every 5 years as either a “move up” or investment property. Given the same scenario from above, by purchasing 6 homes whose value’s are $262,000, the total appreciated value when owning each for 30 years is $5.1 million (4% appreciation), and the potential rental income in today’s dollars would be $90,000 per year, earned just by collecting rental checks.
This is why I’m a strong advocate for long-term, buy and hold real estate. No matter what kind of market you buy into, rental income can pay your monthly bills and over time the asset or home is paid off, allowing you to pick the perfect time to sell when the market is up.
The four main benefits of real estate are:
1. Cash flow
3. Loan amortization
4. Tax shelter.
I have explained the first three and here is how real estate functions as a tax shelter. The IRS has a mortgage interest deduction. In the same example from above with the $250,000 mortgage the tax deduction would be about $9800 per year at the beginning of the loan and slowly decreasing until it is paid off. The second benefit comes in to play with rental properties and it’s called depreciation. The basic principle is the IRS degrades a property’s value down to zero over 27.5 which is considered it’s useful life. In this same example it would average $9000 per year in further tax deductions. This combines for a total tax shelter of $18,800. Combining both tax deductions may even drop you into lower taxable rate from paying 25% in taxes to 15%. On this topic I would definitely contact your accountant to see how it would affect your personal finances.
Yearly Loan Interest Paid $9,800
Mortgage Interest Deduction $9,800
Depreciation Deduction $9,000
Rental income $3,336
Additional Tax Shelter of other Income -$15,464
$15,464 is a paper loss only and may shelter part of your full time income. Speak to an accountant about your specific tax return.
I hope you have enjoyed this and helps give direction to your financial future. For these reasons real estate out performs all other asset classes year after year, decade after decade. It builds long-term wealth, generates monthly income, long-term appreciation, has tax benefits, you can personally manage it, can be financed, your money can be leveraged and most importantly everyone needs a place to live.