A Consumer Guide Presented by;
: The Asher Institute FOR CONSUMERS
A NON-PRFOIT CONSUMER ADVOCACY BUREAU
The Guide was formed in 2003 to educate and inform consumers about various consumer issues so they can make smarter decisions regarding finances, banking and mortgages. This Guide has identified a major consumer misnomer that needlessly costs Americans consumers billions of dollars a year. The misnomer is perpetuated by the banking industry in order to maximize profits and has been very successful due to the misinformed status of the public. This Guide reveals the banking industry’s biggest secret and how consumers can take advantage of it.
This Guid has two sections; Part 1: shows how the profit game works. It shows how consumers are misled into making one seemingly simple decision that winds up costing them their single best opportunity to be wealthy. Part II of the Guid shows that by simply reversing the less-informed decision, wealth becomes something almost every American consumer can easily have, regardless of personal income.
What does the banking industry’s biggest secret concern? Mortgages. When it comes to mortgages, most consumers are knowledgable and able to choose between various loan products and select the right home loan for their risk tolerance. The most highly promoted loan type of all the; “30-Year” Fixed-Rate mortgage, is the one most often selected. Our research revealed some shocking truths about the 30-Year “fixed” that equally stunned both consumers and mortgage industry experts alike.
Consumers choose a 30-Year fixed based on two things and only two things- a low fixed rate and a low fixed payment. But the Guide found that only ONE of those two things is actually true. The other one is false. which one is false? The part about the interest rate being fixed. Contrary to public opinion, the interest rate on a 30-Year fixed -rate mortgage is NOT fixed. That’s right, NOT fixed. You will learn that a 30-Year fixed-rate mortgage is actually an ADJUSTABLE RATE MORTGAGE and the rate consumers are really paying on them is much, much higher than they could ever imagine, completely blocking their paths to financial freedom.
Because common wisdom says that a 30-year fixed-rate mortgage must actually have a fixed rate, it’s an easy sell for the lenders, who profit substantially from the misnomer. The Guide finds nothing wrong with corporations profiting as that is their sole purpose. However, since this particular profit game is the result of a misinformed public, we find the solution is to inform consumers exactly how is all works.
In order to understand the misnomer, you’ll have to learn a lot more about mortgages and this Guide will serve as the medium. We’ll start by just looking at the obvious, how a low-rate 30-year fixed works. On the next page, you’ll see as Amortization Schedule for a low-rate 30-year fixed. This chart shows how much of each year’s payment goes to Principle (to the loan balance, to the consumer) and how much goes to interest (to the lender). For examples throughout this Guide, we’ll use an average American conforming loan, a $150,000 30-year loan at a “fixed” interest rate of just 6.0%. The Amortization Schedule shows how the loan really works, and keeps in mind that at the same rate, it works exactly the same as any other loan amount. Whether a 30-year loan around 6.0% has a balance of $50,000 or $500,000, the proportion of Principle to interest is the same.
$150,000 30-YEAR FIXED-RATE MORTGAGE AT 6.0%
Each year, the consumer pays $10,792 but a different portion of that total gets credited to Principle and to interest. In the first year, $8,950 of the payments go straight to the lender and the remaining $1,842 gets credited back to the consumer. Here are some other facts gleamed from this schedule:
– It takes 19 years before just half the monthly payment goes to Principle, the consumer (%5,482 to Principle, $5,309 to Interest).
– It takes 24 years before 2/3 of the monthly payment goes to Principle.
– After 7 Years, the consumer has paid &75,600 but only $15,541 goes to Principle.
– After 10 years, over 84% of the starting balance is still owed.
– After 15 years, over 71% of the starting balance is still owed. At that point, the consumer has paid $161,000 in payments, more than the original starting balance.
after 21 years, half of the starting balance is still owed. At that point, the consumer will have paid $226,800 with only $75,000 of it going to Principle.
The numbers are heavily skewed in favor of the lender because they are designed to be. It’s due to something many consumers are familiar with, front-end loading interest. Even though the monthly payment is fixed, each payment has a different contribution to Principle than interest, and the contribution to interest in the first years is much greater than in the last years. The result of this system is that the lender collects their interest first, up front.
The Guide found that most consumers know that the interest on mortgage loans in front-end loaded, purposely stacked against them. But we also found that those same consumers, no matter how educated, as well as mortgage industry experts, do not realize that the front-end loaded interest completely throws off the fixed interest rate schedule. Look back at year 1. The consumer pays $10,792 but only $1,842 of it gets credited back to Principle. What if he sold his house after that first year? Would it seem like he paid a 6.0% rate? Look even after 10 years. The consumer pays the lender almost $108,000 but less than $25,000 of it goes back to Principle. That’s no a 6.0% rate. The same holds true for even longer periods of time like 20 and 25 years. So if a 30-year fixed is kept for even 1 month less than 30 years, the rate consumer really winds up paying on it, is higher. How much higher? The Effective Rate Formula reveals what the actual, real interest rate would be if a front-end loaded loan was kept for less than the entire 30-year term.
The =Effective Rate calculation is measure of the actual interest rate consumers pay on their home loans by factoring tin the front-end loaded interest. The formula asks, “What rate would I really pay if I only held a front-end loaded loan for X number of years?”
Using a financial calculator:
PV= equity built in a given time period.
N= number of years being analyzed.
PMT= monthly payment (as a negative sum)
CPT, then I/Y(Compute, then Interest/Year) = Actual Interest Rate
When we applied this formula to our sample 6.0% 30-year loan, the results were as follows:
If our sample 6.0% loan is kept for 25 years, the consumer would wind up paying almost $270K over 25 years for $104K in loan equity. Entered into our formula, the actual rate is 9.43%. That’s right, 9.43%, not 6.0%! And that’s based upon giving up the loan only 5 years early.
Now how much would the real rate be if that loan was kept for 20 years? The answer is 14.82%. What about for 15-years? The answer keeps rising/. It’s a 24.16% interest rate. Paying $161,879 and with less than $44,000 of it going back to Principle shouldn’t seem like a 6.0% rate because it isn’t.
And it only gets worse. Holding on to that low 6.0% fixed-rate 30-year loan for 10 years results in paying an actual 43.48% interest rate. Keeping it for 7 years results in paying a staggering 68% interest rate to the lender. Keeping it for only 5 years results in the equivalent of a 102% rate. Holding it for 3 years yields an actual 182% rate and 1 year a 580% rate!
We informally polled hundreds of consumers as well as mortgage industry experts, some of whom have over 25 years of experience in the business, with the following question: “If you held a 6.0% 30-year fixed-rate loan for 7 years, considering that the interest is front-end loaded and you’re not waiting 30 years for it all to even out, what rate do you think you’d really wind up paying?”
The responses to this question and reaction to the correct answer spurred the development of this Guide. Every time, the consumer or expert guessed between 8% and 12% with an occasional highest answer of “triple,” which would represent 18%.
There was never a guess greater than 18% and yet the reality is that the Effective Rate is actually 68%, almost 400% greater than any guess. The guesses were logical, yet so far off that it became instantly clear that a gross and major misconception on the part of the general public existed.
It was also clear that these numbers had never been disclosed to consumers. Not one respondent had ever heard of an “Effective Rate” calculation of a similar formula. What impacted the Guide the most, however, was the reaction of the respondents after we revealed the actual answer of 68%. One respondent after another was stunned and silenced. It seemed consumers were well aware that mortgage interest is front-end loaded but no one seemed to have any idea just how front-end loaded it really is.
What the Effective Rate demonstrates is that the only way to wind up paying the low advertised Note Rate is to keep the loan for all 30 years. Due to the interest being front-end loaded, the rate becomes ADJUSTABLE based upon how long the loan is kept. On a 6.0% 30-year fixed, the low “fixed” 6.0% Note Rate is the absolute MINIMUM rate a consumer will pay. Even though the monthly payment is fixed, a consumer may wind up paying as much as a 580% interest rate. So a 30-year fixed-rate mortgage is actually an Adjustable Rate Mortgage.
The Effective Rate also shows that the entire concept of the 30-year loan is based upon the single principle of keeping it for the entire term. The banks have been relying upon consumers to concentrate on the fact that it all evens out 30 years later. But how many consumers keep the same mortgage for 30 years? The fact is:
NATIONALLY, HOMEOWNERS KEEP THEIR MORTGAGES FOR:
5 YEARS ON AVERAGE
Whether they refinance, move for a new job across town or across the Country, whether they’re about to have kids or the kids are about to move into college, Americans keep their home loans for an average of just 5 years. They keep their homes for longer than 5 years, but their mortgages for only 5 years. Previously, the long-standing national average was 7 years but with the golden era of refinancing of the early 2000’s , the average has decreased to just 5 years.
By combining the 5-year statistic with the U.S. Department of H.U.D.’s 2003 data which shows the national average mortgage interest rate is 6.16%, the Effective Rate Formula shows us that homeowners, on average, are paying 107% interest rate on their mortgages, what many consider to be their biggest and best investments – most without ever realizing it. And lenders are quietly earning an average of 107% in interest on billions of dollars of home loans, significantly contributing to record profits quarter after quarter.
The Guide believes this fact can’t be understated or underestimated based upon the rates consumers pay on different trade-lines. On cars, they pay between 0 and 15%, on credit cards they pay between 0 an 30% and yet on their “low 6.0% fixed-rate” mortgage, the largest debt of all,. they pay on average rate of 107%. Their credit card balances may be only 15k and the auto loan may be 20k but that super high-rate mortgage has a balance of 100k or 200k or more. Consumers are paying the highest rate on their largest loan.
Now think about this scenario. An average American who earns $50,000/year, has a wife and 2 children, a modest retirement account and a 30-year mortgage. We give him a credit that has a $150,000 balance with an APR of 107% and tell him that he’s now responsible for it – “the debt is his“. What would happen to his family’s life and future outlook if he had that credit card? What would it do to them financially?
The answer is that it would probably devastate his family and severely limit any opportunity they had to gain or build wealth. The numbers prove that the 30-year fixed-rate mortgage is equivalent to a giant credit card with an astronomical APR. Millions upon millions of American consumers have this credit card, this massive liability, which serves as nothing but a giant mountain standing in the way of their financial hopes and dreams. The mountain’s bigger than Mount Everest yet remains invisible due to the deceptive nature of the game. And no matter how much more consumers earn at work and no matter how much their other investments return, it winds up being meaningless in the long run because that home loan, that 107% APR’d “credit card” is sucking the wealth-building power out of them.
Now we’ll look at the Illusionary Profit that occurs when consumers sell their homes. Mr. and Mrs. Miller bought their house 5 years ago for 150k. They took out a 150k 30-year fixed at 6.0%. They lived there happily for 5 years. Then they put their house up for sale and sold it quickly for 190k. Mr. Miller says yo his wife, “See honey, we did well. We picked out a good house in the area, paid the right amount for it and we made a 40 thousand dollar profit.” And they congratulate each other and smile. They’re happy. And so is their lender. Why? Because the game just worked successfully on yet another consumer, in fact so successfully that the Millers are about to buy a new house on the 30- year fixed and start the game all over again.
The Millers played the game, knowingly or not, and they lost. Why? Because they THINK they made a $40,000 profit from the sale of their house. They THINK their biggest investment was a good one, a profitable one. But the problem is that they actually LOST money, not made it. Let’s see how much interest they paid on their 30-year mortgage in that 5 years. They paid 60 payments of $899.33 for a total of payments to their lender of %54,000 and were credited back just $10,500. So they paid $43,500 in interest and yet their house only increased in value by $40,000.
Compare the numbers and you’ll see the Millers might have sold their house for 40k more than they paid, but when factoring in their home loan, they actually LOST MONEY. This also doesn’t factor in the additional costs associated with selling a house, which usually totals 6%, or in this case $11,400. What was supposed to be their biggest, best and most important investment cost them money. And perhaps the worst part of all is that the Millers are under the impression that they made money.
Let’s look at the history of mortgages for a moment. In the early days of American home ownership, mortgages didi’t exist. If someone wanted a house, they had to pay cash in full. Of course, only a few people could afford that. After the Depression, Franklin D. Roosevelt tried to stimulate the economy by offering a sweeping host of reforms with a new set of programs designed to boost the economy, collectively known as “The New Deal“. In it were programs that gave grants to artists just to create art and programs to build unneeded highways just to put people to work. There was also a new agency established to boost home ownership called the FHA, or Federal Housing Administration.
For the first time, it allowed Americans to finance part of their homes by allowing them to put down ‘only’ 80% instead of 100%. Americans would finance 20% of their house on only 2 available terms, 5 and 7-year balloons. They would make interest-only payments on the 20% for 5 or 7 years and when the term cam due, they would ow the original remaining 20%.
Over time, the down payment requirement lessened and the 15-year term was introduced. The 15-year required both Principle and Interest to be paid, which created a higher payment but had no balloon where a large sum would be due. Down payment requirements continued to lessen and more and more Americans became homeowners.
Finally, in order to allow almost every American the opportunity to buy a house, the 30-year term was introduced. The 30-year term was designed specifically for people who couldn’t qualify for a 15-year term and it punished them severely for that. The 30 made home ownership available, but just not affordable due to the way the loan amortizes. And somehow, over time, this was forgotten and many consumers, who could qualify for a shorter term, began to take 30’s. They focused on the lower monthly payment and the free cash flow it created, never looking at how the loan really works. Eventually millions of consumers focused only on the ultra short term and took out these loans that simply weren’t necessary. Lenders collected billions in extra profit as a result, never daring to remind consumers of the benefits of the shorter term as would severely cut into their profits.
Soon lenders began to take advantage of consumer’s complacency and constantly promoted the 30-year fixed as a quality loan by stressing the know fixed rate and low fixed payment. And so what the Guide dubs “The Culture of Acceptance” was sown and reinforced as millions of Americans came to believe that the 30-year was a smart, viable home loan with many benefits. Many others knew it wasn’t a great loan but still took one anyway as it simply wasn’t stigmatic. So people everywhere forgot the importance and history of a short term and regardless of qualification, chose to finance their homes for 30 years. That quick, seemingly logical decision became the single most costly choice for American households as they unwittingly stood in line, choosing to sign up for loans equivalent to giant credit cards with APR’s over 100%!
SHOPPING FOR MORTGAGES
When it comes to shopping for mortgages, the Guide found that consumers have become very adept at finding the best deal in terms of Note Rate and fees. However, the Guide has concluded that they have been misled into shopping for the wrong thing as the basis of their shopping is fundamentally flawed.
Consumers are interested in finding the lowest interest rate so they aggressively search and shop for the lowest Note Rate, which is the advertised interest rate of a loan and widely regarded as being the actual interest rate of a loan. The problem is the fact that the Note Rate has virtually NO bearing on the actual interest rate of the loan. The Note Rate is a 30-year rate. That is, it’s only a valid rate if the loan is kept for all 30 years. So consumers are solicited with low 30-year fixed rate quotes and are trained to shop for that 30-year-based rate quote yet none of them will ever get to pay that low advertised rate because none of them will ever keep the loan for all 30 years.
Consumers will literally cancel transactions with one lender in order to recieve an eighth better in Note Rate with another lender. Yet the Note Rate is virtually meaningless because consumers will wind up paying 10-20 times the advertised Note Rate as demonstrated by the Effective Rate. Certainly, the Note Rate has some importance, as it helps to determine the monthly payment, but again it has virtually no bearing on the real, actual interest rate and that’s what consumers are looking for- the REAL rate.
What helps perpetuate this misconception is the fact that there are no disclosures pertaining to the REAL interest rates of home loans. Consumers are told they’re getting a fixed-rate loan yet at no point are they told that they have to hold it for all 30 years to actually recieve that low rate. There are no forms prior to or at Close if Escrow that discloses the ACTUAL rate the borrower would pay if they kept the loan for less than 30 years. Consumers are never told or required to sign a waiver that discloses that they might actually wind up paying a 590% rate. In fact, there’s not a single document, NOTHING AT ALL, that discloses the ACTUAL interest rates they might pay!
The Guide believes this omission to be a gross misrepresentation to the public at large. We further believe that tat the very least, disclosures concerning the Effective Rate should be required to be signed by borrowers and find it completely negligent that no such requirements are currently in place. As a consumer advocacy organization, we intend to lobby Congressional leaders to initiate such regulation. We anticipate a strong lobbyist effort against our proposals due to the lenders benefiting so substantially from the misnomer but we invite interested consumers to support our efforts by learning more on our Instagram.(Patrick D. Delgado)
Our recommendation for consumers, with respect too shopping for mortgages, is to first consider the Effective Rate. We believe consumers should take the time too critically predict how long they anticipate keeping the mortgage or home. Then they should view create(using the E/R formula) an Effective Rate schedule of each potential loan program so that they can accurately determine the real rate they may wind up paying.
CONCLUSION TO PART 1
The Guide has identified that the 30-year mortgage does not work entirely as advertised and as a result, consumers are paying a much higher rate than they believe. Consumers have come to accept these loans at least partially due to a lack of information, which has misled them to knowingly shop for the wrong product by reinforcing the erroneous perception that the Note Rate is actual, real interest rate of a loan.
The Guide has also identified the solution to the problem, which is quite simple, and is explored in great detail in Part II. You’ll learn that if consumers really want the lowest interest rate on their home loans and want to truly profit from the American dream of a home ownership, they they should NOT be shopping for the lowest Note Rate or lowest fees. Rather, they should be shopping for the shortest possible TERM they can qualify for. Why? Because you’ll learn that the term of the loan has more bearing over the real interest rate than any other factor. Consumers can overturn the profit game by using shorter-term loans to grow wealth at a dramatic pace. Part II will demonstrate how consumers, regardless of income, occupation, assets, gender or stock market performance, can become wealthy and retire early.
Consumers can overturn the profit game simply by swapping out the 30-year loan for one with a shorter-term, essentially removing the giant mountain and replacing it with a highway. No matter how sophisticated the consumer, many misconceptions exists concerning short-term home loans. We” demonstrate these misconceptions to be false and show the benefits of using short-term loans with respect to building wealth.
There are many benefiTs to shortening the term of a 30-year loan, even by 5 to 10 years. For our examples, however, we’ll use a 15-year term. Let’s start by looking at an Amortization schedule of a 15. The loan below is a 150K at 5.0%.
“THE LENDER” “THE CONSUMER” PAYMENT = $1186.19
– 1/2 of the monthly payment goes back to the consumer by year 2.
– 2/3 of the monthly payment goes back to the consumer by year 8.
– The balance reaches half it’s starting point by year 9.
– After 10 years, only 42% of the starting balance is still owed.
Compare the 30-year schedule on the left to the 15 on the right.
Here’s a comparative analysis between the two loans:
1/2 the payment goes to consumer 19 years 2 years
2/3 the payment goes to consumer. 24 years 7 years
Loan balance reaches 1/2 it’s starting point. 21 years 9years
How much owed at end of 10 years. 84% 42%
How much owed at the end of 15 years. 71% 0
On our sample loans, the consumer pays more to principle in the 1st year of the 15, $6890, then in 24 years on the 30. Comparative analysis shows how the two loan types work in completely different ways, despite their similar sounding names. One drains consumer’s wealth, the other builds it.
Now let’s look at the difference at the end of the significant Year 5:
30 Year. 15-Year
Principle Paid. $10,419. $38,164
Total of Payments. $53,960. $71,172
Loan Balance. $129,581 $111,836
Now look at the difference at the end of the Year 15:
30 Year. 15-Year
Principle Paid. $43,427. $150,000
Total of Payments. $161,879. $213,480
Loan Balance. $106,573. $ 0
The dramatic principle reduction of the 15-year mortgage results in its holders substantially larger down payments to put on new home purchases and eventually leads to not having to finance houses at all. Most 30-year holders never experience life without a mortgage payment.
When measuring the Effective Rate, the real interest rate of the loan , the 15 significantly lower than the 30. Look at the Effective Rate on the 5.0% 15 verses the 6.0% 30:
EFFECTIVE RATE COMPARISON
The 15-year has an Effective Rate that is almost 4 times lower than the 30. So the easiest way for consumers to significantly lower the rate on their mortgage is simpply to shorten the term. The old general rule of thumb for refinancing is to lower the Bote Rate by 2%. The new rule is closer to 1% if the cost of the transaction is minimal. Using the Effective Rate formula(and our 5-year average length of ownership) shows that dropping a 30-year 7.0% loan to a 6.0% 30-year loan, reduces the real interest rate from 135% to 102$, 0r 33%. But, refinancing to drop the rate by just 1% from 6.0% 30-year mortgage down to a 5.0% 15, the 5-year Effective Rate drops from 102% all the way down to 28%, a 74% drop in real rate!
When shopping for a mortgage the Guide found the single most important factor to ship for is NOT the lowest Note Rate. It’s also NOT the lowest fees. It’s the TERM – it’s figuring out what the shortest possible term one can qualify for. Why? Because the TERM has more influence over the real rate than any other factor.
COMPARATIVE RATE OF RETURN
The Guide has found a way in which consumes can earn a double-digit annualized return on their money without risk. When it comes to 15-year mortgages, the cost is the monthly payment rises by about 30%. Consumers might be able to consolidate debt do their total monthly outlay actually decreases but let’s assume they don’t consolidate debt and are facing an increase on our sample loan of an extra $286 per month.
We use the formula called the Comparative Rate of Return, which is a comparative analysis between our two loan types. The formula shows that by swapping from a 30 to a 15, the increase in payments generates a solid return on itself. For each extra $286 payment per month, the loan balance goes down by MORE than $286 compared to the existing 30-year loan. Wo we look at the difference between where the loan balance is going to be X years from now and factor in the extra payments to figure out how much of a return is generated by swapping loans.
Here’s the formula:
(difference in equity for X years between 15 and 30-year loans) – (amount of extra pmts) _________________________________________________________________
(amount of extra pmts)
= Annual Comparative Rate of Return
Here’s the result on our sample comparison
Overall, the 15-year cost an extra $51,635 over 15 years but that turned into $10,573, for a 107% return. Annualized, it worked out to a out to a 10% return over the first 7 years and a 7% return over 15 years. This is the best way we know for consumers to earn 7-10%+ without the typically associated risk factor. In fact, often the 15 year annualized rate of return is much higher than 7%. Throughout the Guide, we’ve been using very conservative examples that have only been 1 percept apart, a 6% to a 5%. In reality, the numbers are generally even more in favor of the consumer as many have 30’s at a higher rate than 6.0% and can qualify today for 15’s that more than 1 percent lower.
THE MILLERS VS THE SMITHS
We’ll track two families over time and compare how their futures develop based upon the home loans the chose. The millers take 30’s @ 6.0%, the Smith’s take 15’s @ 5.0% For this comparison, we’ll be conservative and assume that between the ages of 24 and 80, they each take out 8 mortgages that they keep for an average of 7 years, rather than the current average of 5 years. We’ll assume they both lived in areas with the same appreciation rate (5% a year over their lifetimes) and took out the same loan amounts.
The Millers paid to their lender a total of $669,813 to be credited back with only $137,797. At the same time, despite having the exact same income and exact same appreciation rate, the Smith’s allowed their money to work for them. They maximized their income by turning their home into the investment it always meant to be.
While the Millers were eating out 3 nights a week, initially the Smiths were eating out only twice. But while the Millers struggled, the Smiths always had enough equity to do whatever they wanted. In fact, they had hundreds of thousands of dollars of equity so if the stock market turned south or they had a bad year at work or even got laid off, they could absorb it. And when they wanted to go on vacations or buy a nice car or pay for their kids college educations, they could afford to. And when they wanted to retire, they were able to and it wasn’t hard or difficult for them to get there. They didn’t have special educations or special jobs or special anything else. The Smiths and the Millers were identical in every respect other than their mortgages. But NOW they’re not.
The REAL difference between the two families was not income, assets or financial advisor. It was their mortgage and only their mortgage. The Millers GAVE AWAY $532,016 of net earnings over their mortgage-bearing lifetime. $532,016! Of course their lenders were pleased but remained silent as they prefer consumers to follow their marketing and advertising strategies to perfection, kin order to maximize profits. Lenders want consumers to believe that 30’s are acceptable and that 15’s are unaffordable – that’s the BIG GAME.
The Millers look over at the Smiths, who always seem to have money for everything, and think, “They get to do all those things because they’re rich” and they’re right. The Millers think it’s too late to do anything about their own situation and they’re wrong. The Millers have a typical reverse misconception concerning short-term loans. They think they can’t afford one and that people who are on them can afford them because they’re are rich. The irony is that the reason those people can afford them is BECAUSE they’re on a short-term loan. It’s BECAUSE of it, not a RESULT of being wealthy. Short-Term home loans are a CAUSE of wealth, no a RESULT. The Millers and the Smiths started out like the typical American consumer, earning the same income and with the same weak asset base. Built because the Smiths let their largest monthly payment go right back to them, they BECAME wealthy and able to afford everything else.
By taking mortgages on short terms, being wealthy is available to almost anyone who chooses. It is not reserved for only those with special educations and six-figure salaries and those with inheritances or those who are just plain lucky. No, wealth is available to almost EVERYONE and using short-term home loans is the fastest, easiest and most reliable way we’ve found for consumers to get there. It allows consumers to become wealthy without even having to earn more money by simply reallocating the money they already earn in order to maximize it’s impact.
The Guide finds that once consumers are made aware of the facts, they are generally interested in swapping to a short-term loanWhat prevents the swap, however, is a common misconception concerning the notion of affordability. Most consumers simply think that they can’t afford one. However, we find the notion of affordability to be nothing more than a perception of cost to benefit. When consumers fully understand the cost-to-benefit ratio regarding short-term loans, they can clearly and easily see the benefits outweigh the costs to a tremendous degree. The first aspect that demonstrates this is the element of the price break.
The Effective Rate, in conjunction with the comparative analysis on the page 14, leads us to conclude that the 15-year mortgage is approximately 5 times better of a loan. By looking at the payment difference of only $286 between the sample 150k loans, the cost of the 15-year loan is approximately 30% more per month. However, the 15-year loan is not 30% better – it’s 5 times or 500% better. So the consumer gets something many times greater for only a fraction of additional cost, which is a massive price break. We believe this is the most important price break consumers can take advantage of because of its sheer size, because it exists on their largest liability, and because the current loan can drastically improved upon.
Consumers are typically content to recieve a 2-for1 price break. They may
only be interested in one box of cereal but when offered a quantity-based price break, like 2 for the price of 1, they will choose two boxes of cereal.In that case, the consumer is getting something 200% better for no additional cost. When it comes to swapping in a 30-year mortgage for a 15-year loan, the price break is even more dramatic as the consumer receives something 500% better for only 30% more in cost. At a grocery store, this can be compared to encountering a gallon of water for $1.00 and next to it a 5 gallon jug of the exact same water for $1.30. Which one is more affordable? Imagine if you were at a grocery store and saw those two sizes of the same water sitting next to each other. The gallon for $1 and the 5-gallon jug of the same water for $1.30. Which would you choose?
COST FOR BENEFIT
When it comes to swapping to a short-term loan, a common misconception is that the new loan will cost more money. Typically, consumers look solely at the monthly payment difference and decide that the short-term loan is not affordable. Consumers see the extra payment (let’s use $200) as going out the window like a credit card payment. They see themselves as LOSING $200 more per month. They think of the $200 as a COST, when in fact, it’s not a straight into the Mortgage account. That’s ass it is, a simple transfer of funds from one account into the next. And the consumer gets bonus every time, each month for the term of the loan, as demonstrated by the Comparative Rate of Return.
When consumers fully understand what that $200 is doing for them, then they can easily see how that $200 is their single best opportunity to become wealthy. It lays fool-proof plan which enables people to do many wonderful things like retire early, travel the world, send children to college etc. That $200 a month is what makes people wealthy yet when consumers look at the ultra short term and only at the money going out and not coming right back in the other door, they miss out on the fact that the cost-to-benefit ratio is in their favor to an enormous degree.
While the Guide finds the 30-year loan to be equivalent to a giant credit card with an astronomical APR, we find the short-term home loan to be equivalent to the winning lottery ticket. Unfortunately, consumers perceptions have been skewed by the Big Games, resulting in them having great difficulty realizing it. Look at the Smiths. They have almost 500K, enough to buy the exact same things a lottery winner desires. This winning lotto ticket costs $200, per month for 180 months, instead of $1, on time. Is it worth it?
Short-term mortgage holders look forward to their monthly mortgage statement because they’re able to see their net worth growing instead of stagnating, regardless of economic or other market conditions. Each payment is a clear and progressing step to early retirement and those retirement plans become independent from their 401k performance.
INTEREST TAX DEDUCTION
Many consumers take 30-year term mortgages due to their tax-advisors recommendations. We’ve compared the tax deduction and found that this reason is NOT valid. Using the sample loans, the tax deduction after 5 years on the 15-year loan would be $33,007 and on the 30-year loan would be $43,541. The difference is $10,534 over 5 years for a 1-year average difference of about $2000. So if a consumer’s taxable income on a 30-year loan was 45k, then his taxable income on a 15 would be 47k instead, a truly negligible difference. There becomes a greater disparity after 5 years but the difference in equity at that point completely and substantially outweighs the tax benefit.
WHEN TO SWAP
The Guide advises consumers to swap to a shorter-term loan when they can qualify for one with a Note Rate that is 3/4 of a percent lower than their current 30-year mortgage. If they cannot receive 3/4 of a percent lower in Note Rate, we advice consumers to simply pre-pay on their 30-year loan as the benefits of the lower rate do not outweigh the actual cost of swapping at that point. There is, however, clear benefits from the lowering of the rate in addition to the pre-payment when 3/4 of a percent lower can be achieved.
Many consumers wait to swap until they can better “afford” it, sometimes waiting for an anticipated pay increase at work or other debt to be alleviated first. We find this to be another costly misconception due to several reasons. First, in a rising rate environment, the payment on a short-term loan rises faster than the pay increase associated with a stronger economy. Second, as the rate rises the benefits of the shorter term diminish. On a 15-year loan at 4.75%, half the payment goes to Principle in the very first year. At 5.5%, it takes 3 years. At 6.0% it takes 4 years and so on. Finally, the most compelling reason to swap is because each day consumers wait for it to become “more affordable,” they are draining their own wealth on their 30-year loan, therefore making themselves LESS able to afford the short-term loan. Every month that they pay on that giant “credit card,” their ability to afford things in general diminishes. This relates to the irony of having to swap to a short-term loan in order to be able to afford one.
We find that by breaking down the extra monthly payment into a daily basis, consumers can more easily accept the new burden of a higher mortgage payment. In a day and age where consumers seem to only be interested in lowering their payment, an additional $200 per month can seem overwhelming. Yet the burden of coming up with only 7 dollars a day may seem less cumbersome. Consumers can create a variety of methods to save $7 per day, including cutting back on other expenses. They can eat out one less meal per week or bring lunch to work, rent a movie instead of going to one, or even quit smoking. We’ve noticed that once consumers realize the grave importance of that $7 and see it as the key to financial freedom, literally the difference between being asset-rich and asset-poor, it becomes easier for them to find new ways to save it.
THE EASIEST WAY TO A ONE MILLION DOLLAR NET WORTH
The Guide has also identified what it believes is the easiest and most reliable way for asset-less consumers to build their net worth to over one million dollars. By using short-term home loans, we saw how the Smiths took 15’s over their lifetime resulting in a True Net Profit of over $482,000. Now here’s how average consumers can build their net worth to over $1M in a much shorter time frame. The idea is to build equity on a 15-year loan, then cash out enough equity to put 20% down on an investment property that another 15-year loan is take out on. The investment property is rented for just enough to cover the 15-year mortgage payment. This simple process is repeated just a couple times and soon the owner is a millionaire. The goal is simply to let renters build loan equity by letting them pay the 15-year mortgage balance down.
Here’s an example of how effective it is in action:
An asset less consumer swaps today to 150K 15-year fixed at 5.0%. At a 5% annual rate of him appreciation, his house is worth 182K in four years at which point he only owes 120K on the mortgage. He then cashes out 25K as a down payment on the first rental, leaving 20% equity on his Primary Residence so avoid Mortgage Insurance. He buys a rental property for 125K, putting down the 25K and taking out 100K 15-year fixed. He then rents the property out for what the mortgage costs, not looking for profit monthly in terms of cash flow.
Then 4 years down the road, that rental property is worth 160k and he only owes 80k on it. By this time his Primary Residence is worth 220K and he only owes 120K on that loan. Now he has 2 properties(with 180K in equity) to pull out cash from in order to put 20% down for 2 or 3 more rental properties on 15-year terms. No more rentals are needed – in just a few short years., he’ll have a new worth of over 1 million dollars and growing exponentially. The best part is that he only had to make the payment on ONE of those properties – the rest he allowed renters to pay. And he started out exactly where many consumers are today – with on property on a 30-year loan with little-to-no equity.
The key here is to avoid the mistake that most real estate investors make. Most have rental properties on 30-year mortgages and clear a couple hundred dollars per month in rental homes, which usually winds up being spent instead of saved or invested elsewhere. The Guide does not recommend buying rental properties on 30 year terms as it drastically minimizes the impact of the investment. Adding up how many years it takes to make $1 million by clearing a $200 profit on a 30 year loan versus building equity faster on a 15 shows there to be no comparison renting properties on 15 year mortgage is the single fastest easiest and most reliable way to grow net worth from zero to $1,000,000(One Million Dollars).
In conclusion, the Guide believes every consumer who qualifies for a shorter-term home loan should have one. We found that the 30-year mortgage simply doesn’t work as advertised and has had a tremendously detrimental financial effect on American consumers. We feel that once consumers are fully informed, they will clearly see that what they truly can’t afford is to keep paying on a 30-year loan that essentially wastes their hard-earned money and prevents their single best opportunity to be wealthy. We believe the only key needed for consumers to grow wealth without restriction is to swap in their 30-year loans for ones with a shorter term, such as 25, 20, 15 or 10 years. By simply reallocating their income in order to maximize their current earnings, consumers can be wealthy regardless of age, income, gender, luck or any other factor.
– The Asher Institute Report & Consumer Guide was brought to you by the office or:
Patrick D. Delgado, CMPS a Certified Mortgage Panning Specialist and dedicated Consumer Advocate in real estate financing; committed to informing the GENERAL PUBLIC of the common misconceptions of American lending institutions.
For full report or further information regarding the Asher Institute FOR CONSUMERS A NON-PROFIT CONSUMER ADVOCACY BUREAU.