This article is for home-owners. Well-established investors do not need to read.
Use Your House as a Money Tree to Breed More Money Trees
– Simple Methods to Make $Millions
If you are willing to spend twenty minutes to read this article thoroughly, it could make a difference of up to $millions in your life.
In early spring of 2019, my daughter and son-in-law bought a house for $400,000, when they were 24 and 26.
Many people got burned by bad debts, for example, through irresponsible lenders in 2005-2006, and by high-interest credit card debts. So, the society has gone from one extreme to the other extreme.
The society now promotes “debt-free life”, and talks and encourages prepaying and paying off your mortgage early. Assume that my daughter and son-in-law are brain-washed into pre-paying, and will pay off their mortgage in 15 years. That would be 2034 (when she is 39). Assume that the house value appreciates by 4% annually, similar to the long-term national average in the U.S. in the past half a century. Then in 2034, their house value will be $400,000 x 1.04**15 = $720,377.
Here is a review on how to calculate the appreciation in value. Do not be scared by the numbers. This is really easy but very useful math, and will be a beneficial tool for you if you want to invest and achieve financial freedom.
$400,000 appreciating at 4% annually becomes: $400,000 x 1.04 = $416,000 after one year.
After two years, it becomes: $400,000 x 1.04 x 1.04 = $432,640.
After 5 years, it becomes: $400,000 x 1.04 x 1.04 x 1.04 x 1.04 x 1.04 = $486,661.
After 15 years, it becomes: $400,000 x 1.04**15 = $720,377.
As mentioned above, they would pay off the mortgage in 2034. Hence, in 2034, the equity in their house would be $720,377.
The following are three different methods. The difference is night and day.
[1]. Method 1. Fear of debt
As mentioned above, by 2034, they have paid off their mortgage. Then from 2034 to 2062, they keep this house mortgage-free. They hear the slogan that:
“Being debt-free is the new rich!”
So, they do not like debt and they live a debt-free life.
Then my daughter retires in 2062 at the age of 67. From 2034 to 2062 is 28 years. The house value is $720,377 in 2034. Assume that the house continues to appreciate by 4% annually. Then, in 2062, the house value becomes: $720,377 x 1.04**28 = $2.2 million.
Do not be surprised by the big number of $2.2 million. Due to inflation, the $2.2 million in 2062 will be worth much less than the $2.2 million today.
[2]. Method 2. Use equity in their house as the “mother” tree to give birth to more money trees - Use “good debt” to buy rental properties
In 2034, they pay off the mortgage. In this simple illustration, they do a cash-out refinance in 2034 and pull out $500,000 cash.
They use this cash as down payments to buy several rental houses with loans from the banks, and use rental income to pay mortgages and maintenance, etc. This will enable their invested money ($500,000) to grow at around 20% annual rate of return (as demonstrated in the book “$5 Million in 8 Years: Real Estate Investing on the Side”). As in the real-life examples, proper and cautious use of leverage with safeguards can achieve rates of return of around 15% to 30%, even if the housing price appreciates at only 4% annually.
After several years, when these rental houses have accumulated more equity, they repeat the cash-out refinance and pull out more cash to buy more rental properties. The money trees continue to breed more baby money trees. In this way, they maintain a healthy leverage, thereby maintaining the approximately 20% annual rate of return.
Real estate investors need to learn to use safeguards, know what and how and where to buy, understand the local market because all real estate is local, and learn the proven and effective negotiation skills to obtain the best possible deals. These important topics are described in my book “$5 Million in 8 Years: Real Estate Investing on the Side”.
From 2034 to 2062 is 28 years. The $500,000, growing at about 20% annually, becomes by 2062:
$500,000 x 1.2**28 = $82.4 million.
In addition, they still have their first house which has increased in value to $2.2 million, as shown in Method 1.
Therefore, in Method 2, when my daughter retires in 2062, they have $84.6 million.
In this way, they turn the stones and bricks of their house into gold.
This is a simple illustration to avoid complicated math. In reality, I would avoid taking out $500,000 equity at once and buying a bunch of houses in the same year. I would recommend doing cash-out refinances every few years, starting even before 2034. Use that cash to buy rental houses over the years, for dollar cost averaging.
[3]. Method 3. Use equity in their house as the “mother” tree to give birth to more money trees - Use “good debt” to invest in SP 500
Let’s say that they do not want to deal with rental properties. They want to enjoy life.
I tell them that, using the methods shown in my book “$5 Million in 8 Years”, real estate investing requires only a few hours per week.
But young people are stubborn. They do not want to touch rental properties. As mentioned above, in 2034, they pay off the mortgage in their house. In this simple illustration, they do a cash-out refinance and pull out $500,000 cash. Then they pour this $500,000 into an SP 500 index fund. Then they forget about it, except that they take a minute to look at it once at the end of each year (That is what I do with my 401k which is 100% invested in the SP 500). It is simple and stress-free to put money into an SP 500 index fund and then forget about it. As shown in my book, SP 500 beats the majority of the busy and stressful day-traders, and beats the majority of mutual funds.
In the short-term, the SP 500 goes up and down. However, in the long-term, from 1965-2019, with dividend reinvested, the SP 500 has returned an average of 10% annually.
This $500,000, growing at 10% annually from 2034 to 2062, becomes:
$500,000 x 1.1**28 = $7.2 million.
In addition, they still have their house which has increased in value to $2.2 million, as shown in Method 1.
Therefore, using Method 3, in 2062 when my daughter retires, they will have $9.4 million.
No one can predict the future. But if they hold it for almost three decades from 2034 to 2062, the SP 500 should revert to its historic average of 10%/year. Even if it is a little less than 10%, they will still make several millions more than Method 1.
This is a simple illustration to avoid complicated math in the estimate. In reality, I would avoid taking the $500,000 equity and dumping it into SP 500 at once. I would do a cash-out refinance every few years, starting well before 2034. Then I would pour this cash into SP 500. I would repeat this method every few years, for dollar cost averaging.
Huge benefits of “good debt”
Of course, in Methods 2 and 3, they will need to pay a monthly mortgage on the $500,000 that they take out. They will need to pay property tax and insurance on their house no matter what, even in Method 1. Hence, the difference is that they need to pay the principal and interest on the $500,000 loan in Methods 2 and 3. However, the principal is paid into their own pocket, because it reduces the loan owed to the bank. Depending on whether they use a 15-year-fixed or 30-year-fixed mortgage for this $500,000, in either case their payment to the bank will be less than $1 million in the 28 years from 2034 to 2062. In addition, this interest payment is tax-deductible. In contrast, there is no interest to help reduce their taxes in Method 1. Some details are not included in the math, in order to illustrate the important point here. For example, investments have tax issues, as do salaries; please contact an accountant for tax issues. This article focuses on the ideas, without extensive and exact math to bore the readers.
Therefore, in Method 2, they make more than $80 million extra money, compared to Method 1.
Even in Method 3, which is trouble-free and do-nothing, and suitable for a relaxed lifestyle, after the interest payment, they still make about $6 million extra money, compared to Method 1.
What do most home-owners do? They lose $millions that otherwise are theirs
This article uses my daughter and son-in-law as an example. They have read this article and found it helpful, and they will adopt this article in their future planning.
However, the purpose of this article is to help the vast majority of home-owners.
Unfortunately, the majority of home-owners that I know choose Method 1. Many hardworking people and friends that I know use Method 1. Years ago, a couple gave me a brochure describing how to pre-pay and pay off the home mortgage fast, in order to live mortgage-free. In February 2020, another good friend told me that she and her husband had been pre-paying their home mortgage and they are almost done with it, and after that, they will live a debt-free life.
These hardworking people diligently pay their mortgages, sometimes doing pre-pay, to pay off their mortgages early. Then they have a mortgage-free house, with a lot of equity in the house doing nothing. In the process, they lose the opportunity to acquire substantial amounts of extra wealth for the financial security of themselves and their loved ones.
Turn stone into gold
Granted, many people do not want to deal with rental properties. However, they should at least choose Method 3.
Some may ask: “What if I do a cash-out refinance and put the money into the SP 500, and then it goes down by 30%?”
I use two ways to kill the risk. First, as I mentioned above, I would do cash-out refinances every few years and put the cash into SP 500 for dollar cost averaging. For example, do a cash-out refinance in 2010 and invest in SP 500, then repeat in 2015, then repeat in 2020, etc. Second, I would hold the SP 500 for the long-term. If you hold it for only two years, it could drop significantly. However, if you hold it for 20-plus years, you should be fine.
You do not have to wait till you completely pay off your mortgage to start using Methods 2 and 3. For example, if your house value is $400,000, and you still owe the bank $150,000, you can do a cash-out refinance, to use Methods 2 and 3. The earlier you start, the better, due the magic effect of compounding. This can be especially beneficial if you can lock in a low interest rate in the refinance.
Are you willing to leave the crowd and take the less-traveled path?
The traditional and popular Method 1 will make many families to lose $millions.
Most people are not wealthy. Therefore, if you want to be wealthy, you have to be in the minority.
You cannot go with the herd. You have to have independent thinking. You have to have the guts to go against the tradition and go against the popular crowd. You have to rise above the noise, focus on the numbers, and be willing to stand alone.
You have to be willing to leave the crowd, and take the less-traveled path. Because: Only a small minority of people become self-made multi-millionaires.
Summary
The fear of debt can cost home-owners substantial money, in many case making them to lose $millions. In contrast, as shown in Methods 2 and 3, making use of “good debt” with equity in your house can give you huge benefits, up to $millions. It can turn the stones and bricks of your house into gold. The intelligent use of debt to grow money trees can far exceed the income of working hard at a job.
(by David S. J. Meng, author of “$5 Million in 8 Years: Real Estate Investing on the Side”)
