MaxedOutMama

Allow me to explain this another way...following your line of thinking vs my line of thinking, and let's see who wins the race. Calculations taken from:
http://www.goodmortgage.com/Calc_Interest_only_payments.htm
and
http://ray.met.fsu.edu/cgi-bin/amortize

Let's create an example

Brother Jeff and Brother Dan, both buying identical $400K houses next door to each other.

Brother Jeff, who believes that paying down a loan is "building equity" and you should pay-off your loans as quickly as possible, puts 80K down and takes a 15 year fixed rate loan at 6.0% interest, with payments of $2700 per month. If following Jeff's current logic, paying down a loan quickly is "smart," why not do it in 15 years instead of 30, right? Jeff is paying about $1100 a month in principle to start.

Brother Dan, who believes in using as much of the bank's money as possible, and never paying off the loan, gets a 0% interest rate loan at 7.5% interest with payments of $2500 per month. Dan is paying $0 per month in principle. He puts his $80K in a CD earning 4.5%.

4 years go by. Both Jeff and Dan buy new homes and turn old homes into rent houses, moving in new tenants. Their homes are now worth $500K, fully fixed-up and ready to sell.

Question: Did both Jeff and Dan get that $100K increase in value of their homes? Didn't they both benefit from the market increasing the value of their homes?

Question: Isn't that "real" equity? Does the market care what their mortgage balances are?

Question: All that principle that Jeff is paying, is it with PRE-tax dollars or AFTER-tax dollars? Principle payments are NOT tax deductable, Doesn't that make his actual cost HIGHER each month? $1100 is at least $1500 PRE-tax, and goes UP as the loan progresses, and Jeff is FORCED to pay it!!!

10 months later, tenants move out of both houses, leaving them both vacant. Both Dan and Jeff get in an auto accident that lays them-up in the hospital and they can no longer work. Their income is completely shut-off. Jeff's current loan balance, after down-payment and principle pay-down, is $246,175. Dan's mortgage balance is still $400000, but his $80K in a CD has grown to $100K and he can get his hands on it.

Dan works out a forebearance on his loan and makes half payments for 6 months while he gets back on his feet. He's not sweating because he can get his hands on $100K cash if he needs to. His contractor fixes-up the house and moves-in another tenant.

Jeff, on the other hand, has equity in his home, but has no cash on hand. The only way he can get cash is if he refinances to get cash out. That option is out because he is now unemployed and has no income to qualify. He could sell, but because he is forced to sell quickly he has to resort to a fire-sale because of the condition of the house. The bank looks at his house and figures they could sell it "as-is" for $400K, so they decide to foreclose. Jeff sells for $400K at the last minute, and loses his $100K in market gains. Jeff has to start over. He basically gets paid back his own money, the down payment and all of those principle payments, but he didn't make any profit. It could have been worse if the bank did take the property, he would have lost his alleged "loan equity" too. The bank doesn't care that he made all of his payments on-time until the auto accident.

This is "real-world" stuff. Stuff happens to all of us. Banks don't care. Loans don't care. In the words of Jimmy in the movie "Goodfella's,"..."F-ck you, pay me!" Contingencies for life have to be made if you are smart. People's lives change, and this includes you and me. Sooner or later, cash will become tight for anyone. Look at all of those foreclosures. Most every one has to do with an "unexpected change in life," loss of job/income, medical condition, divorce, etc. All things unrelated to our "investing lives" but ABSOLUTELY critical to the success of making those mortgage payments.

The moral of the story? Interest-only loans can be a great vehicle to assist your wealth building, if you know how to use them. You should always have an emergency fund as well. Being forced to pay after-tax principle payments prevents that from happening. You give it to the mortgage company where you can't get your hands on it easily.

Question: If you pay cash for a house, 10 years later have you built more "equity" in increased market value than someone who took out a loan for the same house? This is the disconnect that everybody has their umbilical cord plugged into and they don't even realize it! Paying down a loan has nothing to do with GROWING equity from INCREASING MARKET VALUE, which is TRUE equity growth. If you want to "force" equity into your real estate, paint it or landscape it! You can choose to do those things, if you feel like it, to build equity. The same can't be said for meeting your obligations of a mortgage payment if you failed to set it up that way at the get-go.

Question: Regarding the effect of inflation, what do you think was the size of the average mortgage for the average home was, say, 30 years ago? While we are at it, think about the average wage and take-home pay 30 years ago, and let's throw in average rent and the price of a candy bar 30 years ago. The average mortgage was less than $30,000 30 years ago. Today? About $150,000. Yes the average home size is a bit bigger, but across the board, what's relevant is the average due to the effect of inflation. If you had payments to make on a $30,000 mortgage today, on a house that was worth more than $200K today, would you be sweating about covering that payment? Noooooo!!! You would be thinking of a thousand ways to turn that equity into cash, wouldn't you!!! (Apologies to Ron Starr) But shame on you for not paying off the loan, right? No! Good job protecting your equity all those years, using inflation to your advantage, and keeping your cash where you can get your hands on it!

Question: When Brother Jeff get foreclosed on, is the bank nice enough to pay Jeff back his $80K down payment? Come on! He was a good boy making all those principle payments for all those years, won't the bank cut the man some slack? Noooooo!!!

Question: If you knew that there was no way you could avoid foreclosure, wouldn't you like to know that you are losing the smallest amount of equity possible to the bank? That you had your cash where you could get your hands on it to start over and not the bank? Nobody can foretell a downfall in income but IT HAPPENS TO EVERYBODY!!!! We all get squeezed for cash sooner or later. Just went through it myself. $100K in equity and 50 cents will buy you a cup of coffee...oh wait, make that a $1.50. Damn inflation! Try to buy your honey a steak dinner with all those principle payments you have racked-up in all of your rental properties. Cash is KING.

Question: Follow the money (see if you can figure this one out, Jeff)... the cash of those principle payments, once they leave your bank account, earn what interest and where? Does the house have anything to do with that transaction? Think hard...you have 30 seconds (insert Jeopardy theme music). Answer? Goose-egg!!!

Question: Once you have equity built-up in your rental properties and you want to get some of it out to have some what?...CASH...what are your options? Sell or Re-fi, right? When you receive those funds, aren't you getting back mostly your own money that you paid the bank over the years? From your down payment? From all those principle payments? That's money that came out of your pocket, isn't it? And now you are getting it back...how nice of you to provide it to the bank for ITS use. You earnied nothing on that cash while the bank had those principle payments and down payment, and now you are asking for it back and are now paying interst on it. Good job! So just who was nice enough to hold your hard earned dollars all those years to where you COULDN'T GET THEM BACK EASILY? Thank you bank for being so generous...NOT!

Question: Isn't it good for the BANKS to have all you suckers believe that paying down your loan is "building equity?" Suckers!!!! Why do you think the saying goes for loan officers to tell their clients "interest-only loans are only for rich people." That's right! Because it makes people rich who know how to use them!!! Rich people know the secret! Rich people know how to use their cash on something else rather than tied-up in the banks hands earning 0%!!!! Rich people know how to make more than 0% on their money, so they put that cash to work somewhere else!!!

Question: Why do you think banks don't flaunt interest-only loans? Because "standard" (who says they are "standard" by the way? You or them?) P & I loans PROTECT THE BANK!!! NOT YOU!!! The bank gets less equity if they have to foreclose on an interst-only loan! Each month that you mail in those principle payments, it hedges THE BANK'S position better, not yours! That's good for the BANK, not you! Your balance goes down, but your payments don't, do they?

Question: When the bank gets your principle payments, what does it do with that cash? That's right! They INVEST THAT CASH for their benefit, not yours! Follow your money! And then they put the interest earned on that cash in your bank account, right? SORRY! GUESS AGAIN!!! Why don't you add-up all the principle you paid last year on all of your properties and calculate the interest you could have earned on those principle payments if the cash was in your pocket and not theirs. How about if it was in your pocket in the first place? Don't you think you could have put that cash to work somewhere else? Those of you who still think you are "earning interest" or "paying less interest on remaining balance of your loan" with each principle payment you make have fuzzy logic that benefits the bank, and not your portfolio. You should re-read this paragragh a few times till you "get it." All you guys still doing 1-4 family residences that AREN'T using interest-only loans that are AVAILABLE are UNWISE FOR DOING SO!!! You're hurting yourself and don't even realize it!!! If interest-only loans existed for commercial properties like I have, I'd be all over it!!!!

Question: Add-up all the principle and down-payments you have tied-up in your personal residence. How much interest did you earn for the bank on that money? Could you have put that cash to use somewhere else to build your portfolio? Are you mad yet? I know I was when I realized I'd paid tens of thousands of dollars more than I should have to live in the same house! And can't get my hands on that money easily to use somewhere else.

Question: If you had an interest-only loan and pulled all of your equity out, would the bank be more likely or less likely to foreclose on you if you couldn't make your payments? Would they be more likley or less likely to work something out on a forebearance? If the bank had absolutely no equity to "steal" from you in foreclosure, and knew they would take a loss if they got your house, just how bad do you think they would want to foreclose? If you paid down your loan $50K through principle payments, would they want to foreclose on you more? or less? I hadn't thought this through until someone showed me the "secrets" Ric Edelman points out 3 years ago. I got mad, and so should you.

Question: If you took out a $0 down, interest only loan today on a $400K house, what will your rents and payments look like 30 years from today? The average mortgage? Using history as a guide, $400K 30 years from now will seem like a walk in the park, just like $3OK today would seem on an unpaid mortgage taken-out 30 years ago, and you will be bubbling-over with ever-increasing postive cash flow way before that time, as rents and personal incomes rise with inflation as they always have.

Question: If we slip into a Depression in coming years, wouldn't it be nice to have control of your cash? Let the bank get nothing? They can have your houses, but you have your cash. If a depression happens, don't you think it will happen before your houses are paid off? What will happen to your precious equity then, if you can't make your payments and your tenants stop paying? You will give it back to the bank, and lose all of your equity, that's what!

Question: If you don't have a renter paying you rent, wouldn't it be nice to have a stash of cash to cover the payments that you could get your hands on? Every month that you make those principle payments , you are gambling that nothing bad will happen to you that will affect your income.

They do exist. Most people are not smart enough to ask for them, or the right kind. They do exist, but loan brokers get paid to close loans, not educate consumers on interst-only loans. You should only take advice from people who make more money than you. Who is advising you on your real estate ventures? Your loan broker? how much does he make? You are breaking from the crowd when you start asking for these loans. Only "rich" people have requested them historically. Your loan may only have done a handful during their career, because they personally don't understand their benefits. Should that stop you? Are you comfortable going against the what everybody else does? You want to be careful with these quasi/hybrid-interest-only loans that REVERT to an amortized loan with a SHORTER payback period that can easily double your payment after the initial interest-only period. A lot of foreclosures are happening this way, because people took-out these loans and were not in a position to re-fi when the switch took place. You will be forced to re-fi with these loans basically at that point basically. Taking 10, 15, or 30 years gives you more time. Yes the rate is higher for 30 years, but you guarantee your payment for 30 years and let inflation do its thing, as described above.