Back in 2000, many investors were cocky, much like investors today with the stock market at record highs. I remember asking my Director at the time what he thought about the concept of the mortgage as a forced savings account? At the time, as an investor, it appeared he could do no wrong.
He said, “I don’t need no forced savings account. Only irresponsible people who don’t have the discipline to save every month would consider their mortgage as savings. I’d rather have as big of a mortgage as possible so I can make money in the stock market!”
My Director ended up losing millions when the dotcom bubble collapsed. He no longer looked down on people who slowly grew their wealth. At least, unlike most people, he had millions to lose!
If you have a traditional mortgage that pays down principal and interest, the mortgage “forces” you to save because you are forced to pay your mortgage every month if you want to keep your property. A percentage of each mortgage payment goes towards principal, which can be considered savings.
I’m also in the camp that it’s better for most people to receive a tax refund, even though it’s like giving the government an interest free loan, because most people can’t save for crap!
ARE YOU RESPONSIBLE ENOUGH TO SAVE THE SAME AMOUNT?
After paying off $460,500 in mortgage debt in 12 years, I’ve had time to reflect on whether a mortgage can really be considered a savings account. If this rental property was all I had, I’d be considered “house rich, cash poor” because my ratio of home equity to liquid cash would be around 10:1.
The reality is my physical property portfolio accounts for less than 40% of my total net worth if I exclude my online business. If I include my online business as part of my net worth, then property accounts for less than 25% of my net worth. Contrast this to the average home-owning American who has a scary 80% of net worth in property.
Let’s ignore my property’s appreciation over the past 12 years and solely focus on the $460,500 in debt I paid down compared to whether I would have been able to save $460,500 during the same period. The easiest comparison is principal pay off vs. 401k savings.
If I maxed out my 401k from 2003 – 2015, I would have saved $204,500. That’s exactly what I did. Remember, the maximum contribution limit in 2003 was only $12,000 and slowly rose by $500 to $1,000 increments to the current $18,000 maximum in 2015.
Contributing to a 401k is just as easy as paying a mortgage once you make 401k contributions automatic. The money is deducted pre-tax from your gross income so the hit doesn’t feel as bad and you never see the money in the first place. The issue is, saving $204,500 in my 401k is still $256,500 less than the mortgage debt I paid off during the same period. Even with stock market returns, profit sharing, and company matching, my 401k only grew to a little over $400,000.
Where did the rest of the money go?!
This is the question I think most people have. We spend years making all this money and wonder why we don’t have much to show for all our efforts. Ever wonder where all the cash you withdrew from the ATM went? I do!
The simple reason for not being able to accumulate wealth as prodigiously as expected is because money is like water, and we’re a leaky ship sailing through an unpredictable storm. Something seems to always come up.
A MORTGAGE IS DUMB AND EASY AT THE SAME TIME
Most people responsibly pay their mortgages through the good and bad times. If you don’t, your credit gets crushed, you won’t be able to borrow at normal rates for years, and you’ll ultimately end up losing your downpayment and perhaps more if you purchased in a recourse state.
Given the bottom 90% of Americans have had an average savings rate between -3% – 5% over the past 20 years, it’s clear that most Americans don’t have the capacity and/or discipline to save. We’re bombarded with aspirational ads that make us want to spend. We compare ourselves to our neighbors who make us feel less worthy unless we spend as much or more than them. Credit cards make instant gratification so much easier. And the vast majority of car buyers spend way more than 1/10th of their gross income on a car.
Saving money is hard because society makes spending so easy!
Of course there’s no free lunch given a mortgage requires an interest payment. But statistics don’t lie. The net worth of homeowners is multiples greater than renters partly because of the forced savings component of paying down principal. The other reason is obviously the appreciation of property over time, even if the appreciation is just due to inflation.
It’s hard enough to save an amount equal to the amount of mortgage debt being paid off. It’s even harder to save an amount equal to the total value of the property’s equity thanks to capital appreciation.
What started off as a $120,000 downpayment has now turned into a paid off asset that if sold, would provide over $1,000,000 in cash after commission. I almost don’t care about the 730% increase in equity from the initial downpayment. All I care about is that 12 years later, this property is a wholly owned asset in my portfolio.
MAKE SAVINGS AUTOMATIC
Many renters like to tell me that they “invest the difference” by not owning. It’s a good idea in practice, yet we all know the temptation to splurge tends to derail us from financially wise decisions. A mortgage truly is a forced savings account that has helped many middle class people build wealth over time.
Whether you pay your mortgage, contribute to a 401k, enact a dividend reinvestment plan, or invest in an after tax investment account, make your contributions automatic. If they aren’t automatic, it’s just way too easy to cheat by contributing less or not contributing at all.
Wealth Building Recommendations
Shop around for a mortgage: Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible from them or your existing bank. When banks compete, you win.
Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
Updated for 2019 and beyond.