The Seven Concepts & Seven Steps to Borrow Smart and Retire Rich

Foundations
While your house may be your largest asset, your mortgage (or lack of a mortgage) may be your greatest liability. Trying to manage your assets without learning to manage your liabilities can be like heating your house with the windows wide open.

This book will help you discover ways to use your house as a tool for protecting current wealth and creating new wealth. You will learn that “location, location, location” is no longer just about the physical location of the house. It now incorporates the location of your house wealth as well.

You will come to understand the concept of being debt-free while still having a mortgage. 7-Step Borrow Smart technique to help you Retire Rich. This step-by-step approach will guide you through a simple decision-making process to identify a clear strategy for managing your liabilities.

Food is Not Nutrition
Focus on clarifying for consumers and financial advisors why and how proper liability management could support a plan for wealth creation.
We understood that a key to protecting and building wealth had to do with helping client manage their liabilities first. If we could reduce expenses for the client through liability management, we could increase their ability to build wealth.

Based on the most recent Federal Survey of Consumer Finance, more than 67% of us have wealth in our house than all other savings and investments combined. To clarify the short- and long-term financial impact of decisions made when one buys, refinances, or sells a house.

Wealth and the House
Our ancestors rushed to acquire gold as a foundation of wealth. More recently, Americans have rushed to buy real estate, sell real estate, and borrow against real estate. For many of us, the house may, in fact, represent our own personal gold standard of wealth.
On average during the last 3-4 years, the amount of wealth in a person’s house is outpacing the growth of most other investments.
Currently, 69% of American adults own a house. This will grow to 75% over the next seven years. (Many believe the ultimate dream is house ownership free of any mortgage indebtedness, but that can create savings friction, which we’ll discuss later.)
Increasingly, the house is the key building block for wealth creation. Many Americans believed they needed to save to buy a first house. While this is sometimes true, it’s also possible to save for too long. If your savings growth fails to keep pace with rising house costs, you lose ground.

Since 1945, the median house price in the United States has risen by an average of 6.23% per year.
While there is nothing wrong with enjoying your house purely as a home and investing your savings elsewhere, it is worth exploring how the house compares with other investment over time. The house is a unique investment consideration.

For many Americans, more money will likely flow through their house than will ever flow through their other investments. Properly managed, your investment in the house could account for thousands, even millions, of dollars in potential wealth over your lifetime.
The degree to which you learn to borrow smart will determine the degree to which a portion of that $1,524,446 increases your wealth of others.

If you pay attention to your house investment, you are more likely, to manage that wealth (and the related liabilities) more effectively to increase your savings. If you are willing to take savings you find through this process, and use it to increase your wealth over time, you’ll put yourself in a position to retire rich. One key approach to building wealth is to take any savings found from managing liabilities and use it to increase your assets.

Location, Location, Location
To fully understand the financial impact of prepaying my mortgage and see how it might ultimately lead to various unintended consequences. The decision to locate wealth inside the house is a unique investment product consideration. For most Americans, the house represents a person’s largest single asset (% of net worth) while also representing the largest single debt (% of monthly expense). Therefore, management of the house asset and mortgage debt can have a huge impact on one’s ability to create wealth over time.

No other single investment asset or debt is as misunderstood as the house. If you own your house free and clear, it could still be costing you a great deal of money. If you own your house with a mortgage, you could be focusing too much of your investment savings toward the repayment of your mortgage debt, or leaving too much in CDs or savings accounts that could have repaid debt. The house is a wonderful investment, but like any investment, it needs to be approached from the perspective of Safety, Liquidity, and Return.

Safety
There are four primary risks that could become threats to the wealth in your house: appreciation, depreciation, foreclosure and lawsuit.
Additional wealth invested to pay down a mortgage provides additional security to the lender, not the borrower.

Liquidity
There may be many reasons that you choose not to borrow money, but there are only two reasons to borrow money: (1) you needs to, or (2) you choose to. Smart borrowing can help you move more quickly from borrowing out of necessity – to borrowing out of choice. If you are already borrowing based solely on opportunity, smart borrowing can help you further amplify your future wealth.

Selling the house provides complete use and control of the cash, but one loses the use and control of the house. Borrowing against the house provides complete use and control of the cash and complete use and control of the house as long as one makes monthly interest payments on debt. Most people learn about these obstacles by running into them at full speed while in the middle of trying to borrow against the value of the house for a specific need. This is probably the most painful way to learn a lesson in Liquidity.

- In a standard loan application, most of the first and third pages focus on matters related to Character.
- Before retiring or making a career change, you should set up access to wealth you expect to need from the house.
- The primary obstacle for Character is a job history of two or more years in the same line of work or profession.
- Most of the second page of a standard loan application focuses on Capacity. Maybe you’ve learned the old saying, “Cash is king.” Unless you can pay cash in full for a property, however, cash flow is king.
- When one C is relaxed, expect a tightening of requirements for the other C’s that could increase the interest rate cost, of reduce the amount of wealth available.
- The Capacity obstacle would limit their ability to access wealth in the house, since their income has decrease to $75,000.
- Any change to income or expenses will change your Capacity ratio, and increase or decrease your ability to convert your house value to cash.
- The key obstacle for Capacity is the ability to show income that will support the mortgage and debt payments at a ratio suitable to the lender.
- The Collateral tied to a house is the vale of the house minus any mortgages against the house. If the house is appreciating and the mortgage is being paid down, the lender’s Collateral will continue to increase until the loan is paid off.
- The Collateral in the house helps protect the lender in the event of foreclosure.
- Collateral outside the house helps you maintain use and control of your house indirectly.
- Collateral in the house is more valuable to the lender. Collateral outside the house is more valuable to the borrower.
- The Collateral inside the house protects the lender first, while the Collateral outside the house protects your first.
- Credit measures your ability and willingness to repay your debts on time. Willingness is even more important than ability to repay, but both impact your Credit score. Many wealthy borrowers who have low Credit scores don’t realize that making occasional payments, over time, shows an unwillingness to pay in a timely manner. This can do great harm to their Credit. Someone with $1 million sitting in a checking account who forgets to pay on time can expect to receive the same Credit treatment as someone who has lost his or her job and missed payment because he or she lacked the ability to pay on time.
- A decrease in your Credit score can be a primary obstacle to your use and control the wealth in your house.
- Missed payments can hurt your Credit score over time.
- Ironically, many of these life events accompany an increased need for Liquidity. Events that make accessing the wealth in the house a priority make it more difficult to access this wealth. John F. Kennedy is famous for saying, “The best time to repair the roof is when the sun is still shining.”
- Wealth in the house is much less liquid than most other investments, and various life events can cause it to become totally illiquid.
- The life events that often increase the need for access to the wealth in your house are typically the same events that block such access.
- External threats over which you have little or no control can affect your Credit in a way that immediately blocks future access to your wealth in the house.

Return
Compound interest is “the greatest mathematical discovery of all time.” – Albert Einstein

- We can define Return as the interest or growth you receive on money you lend for another’s use and control.
- Safety is about making sure your wealth will still be there when you need it.
- Liquidity is about making sure your wealth will be accessible when you need it.
- Return is about making sure that your wealth earns interest, or grows for a future purpose. (Because of inflation, the future value of your money will not have the same buying power as it does today.)
- Return must keep pace with inflation to presence its ability to buy the same goods or services in the future.
- Return increases your wealth only to the extent that the Return you earn exceeds the rate of inflation.
- Net worth can only increase or decrease relative to market appreciation or depreciation of the house value.
- Technically, you must subtract inflation for appreciation or depreciation to understand the real impact of net worth.
- This is something over which you have very little control.
- Net equity though principal payments or principal withdrawals have no immediate impact on net worth.
- This is something over which you have a great deal of control.
- The important distinction is that appreciation and depreciation affect your net worth, while principal payments and withdrawals are balance sheet neutral – they have no impact on your net wealth initially.
- It’s never too soon to start managing your wealth inside or outside the house.
- Change in wealth in the house is an external function of appreciation or depreciation, and an internal function of principal payments or principal withdrawals.

EPR
One of the fundamental decisions of borrowing relates to whether to locate wealth inside or outside the house. The initial decision has no immediate impact on net worth, but the long term decision could have a tremendous impact on your future wealth. Wealth located inside the house saves you interest at the current net tax cost of borrowing. Wealth outside the house earns interest or grows at some relative net after tax return on the investment.

Should I pay off my house using a bi-weekly loan payments instead of monthly payments? Should I convert from a 30-year to a 15-year fixed mortgage? If I own a house with no mortgage, should I take out a mortgage on the house and invest the money elsewhere? Should I pay cash for a house?

All of these questions involve decisions about locating wealth inside or outside your house. To help you make those decisions, I offer a simple concept caller EPR, or Effective Percentage Rate.

EPR is the net cost of interest based on the location of money. Remember it’s all about location, location, location. Such benefits to the town were an illusion, in the way that someone without a mortgage believes that they are significantly better off financially than someone with a mortgage. This may not be the case. We would ideally locate our wealth relative to the highest and best use.

A decision based on many things, but one that includes EPR. You could save 4.76% by prepaying when you could have earned 7% by investing. That lost benefit is a cost that often remains hidden.

What if you realize that you are carrying a credit card balance of 12%, and prepaying your mortgage to save 4%? You could increase your Return by 8% by paying your credit card first.

What if your company matched your 401(k) contribution by 25%? Imagine that you are contributing $300 each month to the 401(k) and preparing your mortgage by an extra $200 per month. You have one foot on the gas, and one foot on the brake. Prepaying your mortgage saves you 4.93%, but an investment in your 401(k) earns you 25% from your employer plus the investment Return on the account. You would be better off contributing the extra $200 per month to the 401(k) instead of prepaying the mortgage.

What if you could have a house with no mortgage?
Having your house paid off saves you interest of 4.93% based on current market rates. If your alternative is an investment with an after-tax Return of 8%, then your decision to locate wealth in the house has a Hidden Cost of 3.07%. Market Risk is the risk that your Return on money moved outside the house could earn less than your net cost of borrowing. Discipline Risk is the risk that the ease with which you may access your wealth could increase your chances of spending money that you might otherwise have not spent. With increased Liquidity come increased use and control.

The less self-disciplined you have with your money, the more you need to consider Discipline Risk as a factor in your wealth building strategy. The ability to save money that you don’t need, and or want to spend is an important discipline for Retiring Rich.
If you spend the money that would otherwise be part of your future house wealth, you would have been better off leaving that money inside the house.

Taxes
If you are subject to AMT, your AMT tax rate is 26% or 28%, not the regular federal tax bracket used in the prior chapter table.
One exception is if you have a special arrangement such as a pledged asset mortgage where you can borrow 100% of the loan amount without mortgage insurance.

When selling a house, you want to consider advantages of a tax free gain by using “gain on sale” benefits of IRS Code Section 121. When buying a house, you want to consider the impact of taxes of interest rate deductibility based on IRS code Section 163. The time to make these decisions is at the time of purchase, or at least within 90 days of purchase.

I would advise anyone considering a cash house purchase to talk with a tax advisor before making a final decision. If you borrow, you can pay off the mortgage later. If you pay cash, you establish $0 as your acquisition indebtedness basis, and you’ll be able to deduct no more than $100,000 (if not subject to AMT) should you later decide to take out a new mortgage loan for any purpose other than house improvements. Each year, your mortgage lender must report the amount of interest you’ve paid on IRS Form 1098. The IRS has no formal system in place to monitor this form and separate how much of the interest you are allowed to deduct on your tax return based on either acquisition or equity indebtedness.

This area has been considered one of the top audit watches because of rapidly appreciating house values and billions of dollars in cash-out loans taken by borrower in the last few years. In the future, it would be wise to make the tax nuances part of your planning process when you sell, buy or refinance a house. It’s one more step toward Borrowing Smart. Current law allows a taxpayer to deduct up to $1.1 million in tax deductible interest.

Leverage
Use a very simple formula to calculate leverage: asset controlled/ investment made = degree of leverage. Return and the Rule of 72: Albert Einstein is credited with discovering the Rule of 72 when he was studying the concept of compound interest. The rule is simple. You divide the interest rate you expect to earn into the number 72. Doing this tell you how long it will take for your money to double in value. If you are earning 8% in an investment, divide 8% into 72 and you get 9 years. Your money invested at 8% would double every 9 years. The higher the return the faster the money doubles, and vice versa. That’s how leverage acts like a time machine for your money. Leverage can amplify the Return, reducing the time it would take for money to double in value. Using our formula for growth: $208,000 (current investment value) - $200,000 (original investment value)/ $100,000 (cash used to control the asset) – 8% (growth rate on the cash used to control the asset).

You can see above how slight moves in appreciation, combined with different degrees of Leverage, lead to wide variations in growth rates relative to the wealth used to control the asset. In the U.S. economy, more private wealth has been created through real estate than through any other single investment. Americans’ house wealth wasn’t created through the investment of vast sums of money. Rather, it came from relatively small sums that worked over time with the powerful impact of both compound interest and Leverage. The result: new wealth based on “compound leverage.”

Leverage amplifies force. In the case of financial Leverage it increases or decreases the rate of growth to the degree it is used.
The primary example of Leverage in real estate is the use of a small down payment to control a higher-value house. If you borrow, you are using Leverage. If you pay cash, there is no Leverage employed. Compound Leverage is why real estate is such a great wealth creator in the U.S. Bonds are debts that an issuer owes to a holder based on a specific interest rate and maturity. Mortgages have an issuer (borrower) and a holder (lender), they have a specific interest rate and a maturity. The wealth located inside a house would be most closely aligned with the asset class called bonds.

Money located inside the house saves you interest as a rate very similar to money located outside your house invested in bonds. What if we considered equity in your house as part of your bond portfolio? If we included the $40,000 house equity as part of your overall portfolio, the portfolio is $140,000. The addition of house equity as a relative bond investment shifts the actual asset allocation. It brings into question whether the portfolio is truly Aggressive, Moderate, or Conservative. If you find that too much of your savings is in bonds, after adding the house wealth to your calculations, you could move some of your existing bond portfolio into stocks. Or, you might stop making extra principal repayments on your mortgage as a way of rebalancing over time. You may even want to consider an interest-only mortgage that would allow you to increase employer-matched 401(k) investments. Another alternative is to consider life insurance that provides a guarantee of principal for added safety, guarantee of access for liquidity, and indexes with market returns for potential future gains net after tax gains.

The house wealth, if incorporated into your overall financial plan, may disturb the perceived diversity of your current investments. Consider your time horizon and risk tolerance before making a decision to leave the house wealth out of your long-term financial plan. Over a 30 to 60-Year period, even small decisions can have a tremendous impact on your wealth creation if you take action to employ that savings to build new wealth.

In this game, you are given a variety of products that you can use to transport your cash; we’ll call these products “buckets.” You can choose which buckets to fill each month from your “faucet” of current cash flow. Some of these buckets would increase your future wealth, while others would increase the future wealth of others. You are competing only with yourself. Given that personal cash flow is relatively fixed for most of us, you have to decide whether to find and repair the current leaks or to continue to swap one bucket for the next, always hoping for a better bucket. You will come to quickly to realize that the bucket you have today fills more quickly when the leaks are repaired, regardless of what kind of bucket you are filling.

You may also come to see that the largest bucket you fill each month is the bucket of money related to your house.
Or, you can learn the rules and choose to play with a higher degree of awareness.

Product
Interest rate risk is the risk involved in the rise and fall of interest rates over time. Given that most borrowers can easily adapt to falling rates, you should be most concerned with rising interest rates that expose you to higher payments. The National Association of Realtors often cites 5.7 years as the average life of an existing house of loan transaction. The Joint Center for Housing Studies at Harvard University shows the median age of a mortgage loan refinanced since 1993 as only 3.29 years. Why so low? Because people refinance more often during periods of falling interest rates. If the Thompsons had realized their 30-year loan Product would end up being replaced every 7 years, they may have chosen an “ARM” which stands for Adjustable Rate Mortgage, as a more suitable choice. Would have saved the Thompsons an average of $130.83 per month. That amount invested over 57 years at an average Return of 8% could have grown to $1,572,948!

The 7-Step Borrow Smart Solution aims to help you pay off your house years early or add $1,000,000 or more to your retirement savings.
They could have paid it off in 21.5 years. If you were to choose the right loan Product to Borrow Smart over your lifetime, you might find that this one Step could provide you with enough additional savings to Retire Rich. The Short Term ARM is an aggressive Product approach. The Intermediate Fixed ARM is a moderate Product approach. The Long Term Fixed is a conservative Product approach.

Payment
“ Payment” refers to the approach you will take to repay your mortgage over time that best fits your current specific borrowing needs. There are essentially three ways to repay a mortgage loan: Amortizing, Interest-Only, Negative Amortizing

The word ‘amortize’ stems from the Old French amortir, amortiss – “to bring to death.” If you had a 30-year interest only loan of $160,000 at 7%, your monthly payment would be $933. After 30 years, you would have paid a total of $336,000 in interest, and no principal. If your interest were tax-deductible (based on a 35% state and federal bracket), you would have saved $117,600 in taxes. You total interest payments of $336,000 (minus) $177,600 in taxes saved equals a net interest cost of $218,400 to maintain the mortgage balance of $160,000. Thus, in the interest only payment example, the net interest cost of the $160,000 loan is approximately 137% of the principal amount originally borrowed. This is a great deal higher than the amortizing payment. The amortizing loan had total after tax payments of $305,090 to pay the loan balance to $0, while the interest-only loan had total after tax payments of $218,400 to maintain the balance of $160,000. This difference in cost - $305,090 minus $218,400 – is $86,690 in cash flow savings to the interest-only borrower. This $86,690 over 360 months is equivalent to $240.80 in average monthly cash flow. If you spent the $240.80 in monthly cash flow, you would need $160,000 to pay down the loan to $0 at the end of the loan term. However, if you invested the $240.80 in an investment earning a 7% after tax return for the 30-year period, it would grow to $293,769. After paying off the loan balance of $160,000, you would still have $133,769 in net savings. If you reduced your $218,400 interest cost by the remaining $133,769 in your investment account, your net interest cost would be only $84,631.That’s approximately 52% of the $160,000 principal amount originally borrowed. Consider this a great strategy for someone with money to increase wealth, but a risky strategy for someone without money. If you choose an interest-only loan, or negative amortizing loan, compare the payment you would have made to a current 30-year fixed. The increased cash flow from the Payment approach you choose, if there is one, will be added to your monthly savings, or used to prepay your new mortgage. Any time you borrow in the future using an interest-only or negative amortizing loan; you’ll use the amortizing loan payment as your benchmark for the additional amount to add to your savings. Borrow Smart to increase your future savings, not to buy a house you can’t afford.

Availability
“ Availability” refers to the maximum amount you would be qualified to borrow for your mortgage. It is not the amount of money you should borrow. Rather, it is the maximum amount you are allowed to borrow. Once you have chosen your Product (Step 1) and Payment (Step 2), then Availability (Step 30 will help you understand how much you can borrow.

Availability is the amount you are allowed to access through borrowing. Once you know your Availability, you can determine the Amount you will actually borrow. Think about how your profile as a borrower might change over time and how this could affect your ability to borrow. Consider borrowing before you change careers, retire, begin divorce proceedings, or accept a commission-based job.

Amount
“ Amount” refers to how much you borrow when you refinance or buy a house. The Amount you borrow may be either a function of simple necessity or a more complex matter of opportunity. It is always limited by Availability. Remember, we define a debtor as someone who borrows solely out of necessity. A debtor is dependent on a lender to provide the Amount needed. When the lender offers an option to borrow more than you actually need, it presents an opportunity for a debtor to act as a Creditor. You are still a debtor in the strict sense of the word; however you borrow out of choice rather than necessity to capitalize on a financial opportunity. If you have little or no savings, then your choices in financing a house are likely to be determined by the Amount a lender will allow you to borrow.

If your current savings exceeds the purchase price (or house value), then your decision to borrow is often one of opportunity.
When determining the Amount of your loan that is tied to opportunity, you will want to consider the concepts of Safety, Liquidity, Return, EPR, Taxes, Leverage, and Diversification. Assuming you wish to focus on maximizing wealth when you have the flexibility to borrow based on an opportunity, not just necessity, your decision is basically whether to locate wealth inside or outside the house.

Based on what I know today:
• Do I feel I would have a higher degree of Safety by having the wealth inside the house or outside the house?
• Do I think I would have a higher degree of Liquidity by having the wealth inside the house, or outside the house?
• Do I think I would have a higher Return/EPR by having the wealth inside the house or outside the house?
• How would having the wealth inside the house, or outside the house impact my tax subsidy to offset the cost of borrowing?
• How much Leverage do I want to use, knowing that the degree to which I use leverage is the degree to which I magnify my gains or my losses when borrowing?
• How have I considered my house wealth in relation to my overall Diversification of my other investments?

The increased cash flow could be used to increase savings that help you avoid future consumer loans, breaking a cycle of debt. A large initial investment compounded over time can outperform smaller monthly investments adding up to the same amount. It could also be easier for a borrower to decide all at once to keep wealth outside the house by making a lump sum investment, rather than deciding each month to continue making smaller monthly contributions. Any pay-down of higher external EPR debt using lower internal EPR debt will create Borrow Smart cash-flow savings. To achieve the long term goal of Retiring Rich, however, you must maintain your savings and not spend the money. If you are Conservative, and the EPR of money inside your house is higher than the EPR of money outside your house, then you should consider leaving any current house equity inside the house, and consider additional savings that could be used to reduce that interest expense. If you are more Moderate in your approach, consider using any remaining savings or cash for investments that at least keep pace with your cost of interest, providing you a greater diversification and increased liquidity. If you are more Aggressive in your approach, borrow the maximum you can and invest in higher return opportunities to build additional wealth over time. If you can’t earn a return higher than your cost of borrowing, you may need to use your cash flow to repay your mortgage.

Management
“ Management” refers to your ongoing strategy for Borrowing Smart and Retiring Rich. The effective management of both your liabilities and your assets is imperative. Self-awareness of my own strengths and weaknesses dictated that I surround myself with a team of professionals to help me reach my goal to Borrow Smart and Retire Rich. There are different ways to establish a financial team, but the end result is to increase your ability to make smart decisions each step of the way. My hope is to inspire you to begin managing the wealth in your house. Through this process you can come to understand what choices are appropriate as your income and expenses rise or fall over time and various life events impact your finances. Would you rather pay off your house early or add $1 million or more to your retirement savings? Most of us have an emotional bias toward simplicity of having no debt, even when it is financially advantageous to carry a loan. In planning when to pay off a mortgage, however, I encourage you to build in as much flexibility as possible. Instead of making it your first goal to be debt-free, consider setting a goal of having your liabilities fully support your long term goal of building your future assets based on your current, specific needs. At a minimum, make sure that someone on you team will take the time to review your situation when needed, there is no greater commitment they can make. I recommend a three-part review. First, note any personal changes that have occurred during the last year, to help fine-tune your current borrowing strategy. In the second part of the annual review, look at market considerations. The third step is to review cash flow in relation to your long-terms goals.

Protection
“ Protection” refers to the approach you will take to always maximize the Safety and Liquidity of your wealth inside the house? I believe the equity line of credit is the single most overlooked financial planning and lending tool available today. The average American has about $27,000 in cash, money market and liquid bank deposits, according to the most recent Federal Survey of Consumer Finance. This money typically earns interest at a rate lower than the rate of inflation. Replace the ‘cash’ emergency fund with an equity line of credit. Employ the cash so it can grow to increase future buying power through investment that keep pace or exceed inflation. Once you have an equity line of credit, changes in your Character (job), Capacity (income), Collateral (value), or Credit (scores) will typically not affect your ability to use the line of credit, even if you become ineligible of other types of financing.

Discipline
“ Discipline” refers to your ability to stay the course. I like to think of Discipline as a state you achieve when you integrate what you know into your daily actions. With a little Discipline, most people living in a healthy economic environment can create wealth over time. In deciding how you will manage wealth in your house, it is important to maintain self-Discipline in terms of how you borrow from yourself. Your house can be your sole source of borrowing, but if you borrow from yourself, you must play fair. Let’s say you pay off $30,000 in auto and credit card debts through the refinance of your mortgage. Your cash flow increases by $600 per month. When you invest that money, you become the lender and earn interest from others. Remember, those who understand interest earn it; those who don’t pay it. The dynamic at work here is that you start to understand how your cash flow and interest create wealth for you, or for the lender, but someone is taking advantage of that wealth. Thus, there are four stages of wealth: Build; Manage; Spend; Transfer

Moving Ahead
Think of it this way: If you were lost, and you could have either a map or a personal guide to help find you way, which would you choose?
Ask clients if they’d rather have Tiger Woods’ golf swing or his golf clubs? The book is about your swing.
No one product, or club, will solve your problems unless you’ve “got that swing!”