Why Pay Cash for your House Part 1

Summary

In this video, Kurt Jackson, a certified mortgage planner, challenges the common belief that paying cash for a house is always the best financial decision. He explains that equity in a house yields zero percent return and that mortgage payments can be offset by tax deductions. Jackson introduces the 'Effective Percentage Rate' (EPR) to help viewers make informed financial choices, illustrating that investing the money instead of paying in cash could lead to significant wealth accumulation over time, thus transferring wealth when not fully understanding money's potential.

Takeaways

• 🏡 The speaker, Kurt Jackson, is a certified mortgage planner aiming to help clients make informed financial decisions about their homes.
• 💡 He encourages viewers to watch a follow-up video to consider the implications of paying cash for a house versus financing it.
• 🤔 Kurt raises the question of whether the common desire to avoid mortgages for peace of mind is the best financial strategy.
• 🏚 Historically, the fear of mortgages stems from the Great Depression, when many homeowners lost their homes to foreclosure due to demand features in mortgages.
• 📈 Kurt explains that equity in a house, even 100%, has a zero percent rate of return, contrary to the common belief that it provides a return on wealth.
• 💰 The value of home equity lies in potential monthly savings from not having a mortgage or a smaller mortgage payment.
• 📊 The script discusses the concept of opportunity cost, highlighting that paying cash means giving up the chance to invest and earn returns on that money.
• 📉 Kurt provides an example to illustrate that investing the money saved from not paying a mortgage could potentially yield higher returns than the savings from avoiding mortgage payments.
• 🧮 He introduces the Effective Percentage Rate (EPR) as a formula to help make financial decisions, considering the after-tax cost of debt and the after-tax return on investments.
• 💹 The script uses an example to show that investing the money for a house could result in significant wealth accumulation over time compared to paying cash upfront.
• 🚫 Kurt concludes by advising against paying cash for a house due to the potential loss of wealth through missed investment opportunities and encourages viewers to watch the next part of the series for further insights.

Q & A

Who is Kurt Jackson?

Kurt Jackson is a certified mortgage planner in Liberty, Missouri with over 17 years of experience in the mortgage industry.

What is the main topic of the video?

The main topic of the video is about the considerations and potential drawbacks of paying cash for a new house.

Why do people prefer to pay cash for their homes?

People prefer to pay cash for their homes to avoid having a mortgage payment each month, seeking peace of mind and financial security by having no debt.

What historical event influenced the perception of mortgages in the United States?

The Great Depression influenced the perception of mortgages, as many homeowners with mortgages lost their homes due to foreclosure during that time.

How has the mortgage system changed since the Great Depression?

Mortgages no longer have demand features, and banks are insured by the FDIC, reducing the risk of foreclosure if payments are made on time.

What is the rate of return on home equity?

Home equity has a zero percent rate of return because the value of a house appreciates regardless of whether it is fully paid or financed.

What is opportunity cost in the context of paying cash for a house?

Opportunity cost refers to the potential earnings lost by paying cash for a house instead of investing that money elsewhere.

What is the Effective Percentage Rate (EPR) formula?

The EPR formula considers the after-tax cost of debt and the after-tax return on investments to help make financial decisions.

How does having a mortgage compare financially to paying cash for a house?

Having a mortgage can be financially beneficial as the potential earnings from investing the cash may exceed the cost of the mortgage interest.

What is the long-term financial impact of investing cash instead of paying off a house?

Investing cash instead of paying off a house can result in significant additional wealth over time due to compounded returns, as illustrated by the example where $400,000 invested at 6.5% after-tax return yields over $814,000 in 30 years.

Outlines

00:00

🏠 The Risks of Paying Cash for a House

In the first paragraph, Kurt Jackson, a certified mortgage planner, introduces the topic of paying cash for a house and its potential pitfalls. He explains that while many people opt to pay in full to avoid monthly mortgage payments and seek peace of mind, this decision may not be financially savvy. Historically, the fear of mortgages stems from the Great Depression when many homeowners lost their homes to foreclosure despite making timely payments. This fear has been passed down, leading to a belief that owning a house outright is the best financial move. However, Kurt challenges this notion by explaining that equity in a house, even 100%, has a zero percent rate of return and that the real value comes from the potential savings or investment opportunities that could be gained from not paying cash upfront.

05:01

💰 Understanding the Opportunity Cost of Paying Cash

The second paragraph delves into the concept of opportunity cost when choosing to pay cash for a house. Kurt Jackson illustrates that by paying cash, one foregoes the chance to invest that money elsewhere and earn a return. He uses the example of a $100,000 house to show the difference in savings between paying cash and financing with a mortgage, highlighting the tax benefits of mortgage interest deductions. The Effective Percentage Rate (EPR) is introduced as a tool to evaluate financial decisions, comparing the after-tax cost of debt with the after-tax return on investments. Kurt demonstrates that investing the money for a potential return can significantly outweigh the savings from avoiding a mortgage, suggesting that by paying cash, one could be missing out on substantial wealth accumulation over time.

Keywords

💡Mortgage Planner

A mortgage planner is a professional who advises clients on mortgage-related decisions. In the video, Kurt Jackson introduces himself as a certified mortgage planner, indicating his expertise in guiding people through the process of financing their homes. His role is central to the video's theme, as he aims to educate viewers on the implications of paying cash for a house versus taking a mortgage.

💡Peace of Mind

Peace of mind refers to a state of mental and emotional calmness and stability. In the context of the video, it is mentioned as a primary reason why people prefer to pay cash for their homes—to avoid the recurring worry of monthly mortgage payments. This concept is integral to understanding the video's message, as it contrasts the perceived security of being mortgage-free with the potential financial benefits of maintaining a mortgage.

💡Great Depression

The Great Depression was a severe worldwide economic downturn that took place mostly during the 1930s. The video references this historical event to explain the origin of the fear and aversion to mortgages. During the Great Depression, many homeowners lost their homes due to foreclosures, which has contributed to the perception of mortgages as risky, even though modern mortgages do not have the 'demand features' that led to such widespread losses.

💡Equity

Equity in a home refers to the difference between the market value of the property and the amount still owed on its mortgage. The video script discusses the misconception that having 100% equity in a house provides a rate of return. It clarifies that equity itself does not generate income but can be leveraged to save on monthly payments, which is a key point in the argument for considering the financial implications of paying cash for a home.

💡Appreciation

Appreciation in real estate means an increase in the value of a property over time. The video uses the example of a $100,000 house appreciating by 5% to illustrate that the equity percentage one holds in a property does not affect the appreciation rate. This is a critical point in the discussion about the financial benefits of mortgages versus paying cash for a home.

💡Opportunity Cost

Opportunity cost is an economic concept that represents the potential benefit an individual, investor, or business misses out on when choosing one alternative over another. In the video, the opportunity cost is discussed in the context of paying cash for a house versus investing that cash to potentially earn a higher return. This concept is crucial for understanding the video's argument against paying cash for a house.

💡Effective Percentage Rate (EPR)

The Effective Percentage Rate (EPR) is a financial metric introduced in the video to help viewers make informed decisions about debt and investment. It represents the after-tax cost of debt and the after-tax return on investments. The EPR is used in the script to demonstrate how maintaining a mortgage and investing the cash elsewhere could result in a net positive income, which is a central argument of the video.

💡Tax Deduction

A tax deduction is a reduction of an individual's taxable income, allowing them to pay less in taxes. In the context of the video, mortgage interest is often tax-deductible, which lowers the effective cost of borrowing. The script uses this concept to show that the actual cost of a mortgage can be significantly less than the stated interest rate due to tax savings, which is a key factor in evaluating the financial wisdom of paying cash for a home.

💡Investment

Investment in the video refers to the act of allocating funds to financial assets with the expectation of generating income or profit. The script encourages viewers to consider the potential earnings from investing the cash they would otherwise use to pay for a house in full. This is a fundamental concept in the video's argument, as it suggests that the returns from investments could outweigh the benefits of paying cash for a home.

💡Wealth Transfer

Wealth transfer in the video refers to the potential loss of financial gains that could have been achieved through wise investment decisions. The script uses the term to highlight the long-term financial impact of choosing to pay cash for a house instead of leveraging the funds to generate higher returns through investments. This concept is used to emphasize the potential financial downside of not fully understanding the power of money.

💡FDIC Insurance

FDIC insurance is a guarantee provided by the Federal Deposit Insurance Corporation for deposits in banks. Mentioned in the video to assure viewers that modern banks are insured and the risk of a 'run' on banks is minimal, this concept is used to dispel outdated fears associated with mortgages and to encourage a reevaluation of the financial strategy surrounding home purchases.

Highlights

Kurt Jackson, a certified mortgage planner, aims to provide information to help clients make the best financial decisions, especially regarding their homes.

The video series discusses the common misconception of paying cash for a house to avoid monthly mortgage payments for peace of mind.

The desire to own a house free and clear stems from the fear and hatred for mortgages, a sentiment rooted in the Great Depression.

During the Great Depression, banks could call mortgages due at any time, leading to many foreclosures despite timely payments.

Modern mortgages no longer have demand features, and banks are insured by the FDIC, reducing the risk of foreclosure.

Equity in a house has a zero percent rate of return, contrary to the belief that it provides a return on wealth.

The value of equity lies in potential monthly savings from not having a mortgage or a smaller mortgage payment.

Mortgage interest is often tax-deductible, reducing the actual cost of borrowing money.

Paying cash for a house means giving up the opportunity to invest and earn returns on that money.

The Effective Percentage Rate (EPR) formula helps in making informed financial decisions by considering the after-tax cost of debt and return on investments.

Investing the money saved from not having a mortgage can potentially earn significantly more than the savings from avoiding mortgage payments.

Paying cash for a house could result in a substantial loss of wealth over time due to missed investment opportunities.

The video series illustrates the concept of 'transfer of wealth' when people make uninformed financial decisions.

Understanding how money works can alleviate worries about having a mortgage and allow individuals to make smarter financial choices.

The video encourages viewers to watch the second part of the series for further insights on the topic.

Transcripts

hello my name is Kurt Jackson I'm a

certified mortgage planner in Liberty

Missouri in my more than 17 years in

this business I've seen a lot of smart

people make big mistakes surrounding

money and with that experience one of

our goals is to provide enough

information for our clients to be able

to make the best decision surrounding

money especially surrounding their house

today's subject is about is for those

folks those of you that are thinking

about paying cash for your new house now

before you pull the trigger on that I

want you to spend a few minutes to watch

this video and the second in this series

to see if you really want to go through

with that plan the second video will be

right below this one on the computer

screen so all you have to do is scroll

down and click on it what we found is

that people like you that have the

ability to pay cash for their home do so

for many reasons the main reason we

found is that you don't want a mortgage

payment hanging over your head each

month in other words you're seeking

peace of mind that sound about right

almost everyone we talked to a quick

peace of mind with not having a mortgage

on their house in other words Americans

equate financial security with having no

debt let's see if that's actually the

best direction to go our research

uncovered that the reason people feel

this way comes from the fear and hatred

we have for mortgages owning your house

free and clear the concept that's been

ingrained in our psyche since way back

in 1929 when the Great Depression

millions of homeowners with mortgages

lost their homes now these were good

folks that were paying their mortgages

diligently but due to circumstances

surrounding the Great Depression those

good folks lost their homes to

foreclosure see during the Great

Depression mortgages had what they call

demand features this meant that a bank

could call the mortgage due whenever

they wanted to or needed to so millions

of good people lost their homes even

though they were making their payments

on time each and every month and this is

really where our parents or our

grandparents determined that you should

own your house outright and then a

mortgage was an S

very evil at best and it appears that we

haven't changed our thinking for more

than 75 years even though mortgages no

longer have a demand feature and banks

are insured by the FDIC so there's no

chance of a real run on them without the

demand feature the only way you could

lose your house to foreclosure is if you

don't make the payments but somehow

somewhere someway we came to the

conclusion that having no mortgage on

our house gives us some kind of rate of

return on our wealth or the equity

inside the house now let's make sure we

fully understand what having equity in

our house does does either for us or

does to us first of all we found that

the equity in our house has a zero

percent rate of return well let me

explain why if you were to buy a hundred

thousand dollar house and 101st Street

and you paid cash for that house then

you owe nothing on the house and have no

mortgage payment if we assume

appreciation is five percent okay in a

year your house would then be worth a

hundred and five thousand right so let's

say I had the same taste in houses and I

bought essentially the same house across

the street from you at 101 first Street

I paid a hundred thousand dollars also

and even though I had a hundred thousand

dollars in cash I chose to finance a

hundred percent or a hundred thousand

dollars so I could keep all that hundred

thousand dollars in my pocket now I do

have a mortgage and a mortgage payment

that you don't have and I'm going to

address that later but if our houses are

basically the same and your house went

up five percent over that year wouldn't

it make sense that mine did too so my

house would be worth a hundred and five

thousand also so the fact you had a

hundred percent equity and I had no

equity both our houses went up five

thousand dollars therefore having any

equity even one hundred percent equity

has a no rate of return it has

absolutely no bearing on the value of

the house and that's where the rate of

return comes from now before we lose you

on that that idea let me say that having

equity does have some value that value

is in the form of monthly savings the

savings you would have by not having a

a mortgage or by having a payment on a

smaller mortgage right so if I borrowed

that hundred thousand dollars at seven

percent I pay seven percent in interest

over a year

I'm sorry seven thousand dollars in

interest over a year but mortgage

interest is normally deductible if I'm

in a twenty eight percent federal

marginal tax bracket and six percent

state I'm able to write off thirty four

percent of my interest that's reducing

my tax bill

well thirty four percent of seven

thousand dollars is two thousand three

hundred eighty dollars so my total cost

is only four thousand six hundred and

twenty dollars

well that equates to a net cost of four

point six two percent so that means that

you are saving four point two six about

four point six two percent by not having

a mortgage on that house now if you gave

your financial advisor a hundred

thousand dollars to invest and he earns

you a non compounding four point sixty

percent on your money each and every

year how long would he be your financial

adviser the next thing our research

uncovered was that when someone decided

to pick cash for their house they aren't

really thinking about what they're

giving up if they had invested that

money instead of paying cash we call

that an opportunity cost when you think

about opportunity cost it becomes

evident that everything we buy is 100%

financed even when we pay cash now why

is that well because when we pay cash

for something we gave up the opportunity

to do something with that money

we gave up the opportunity to invest it

somewhere else now as we discussed

earlier if you paid a hundred thousand

dollars cash for your house you gave up

the opportunity to earn money on that

hundred thousand dollars now remember in

our example since you had no mortgage

you're saving four point six two percent

after-tax so putting the hundred

thousand dollars down means you're

saving four thousand six hundred twenty

dollars each year now that amount

doesn't change or grow unless your tax

bracket drops or goes up so the key

question you should ask yourself is how

much could I earn if I had invested in

that money

now through our research we uncovered a

proven formula to make decisions help

you make decisions with money when we

based decisions on these formulas we

then know that we're properly allocating

all of our assets our formula is called

the EPR the effective percentage rate in

the EPR is really the after-tax cost of

all of your debt oh and the after-tax

return on your investments now we've got

another video that we've done that goes

into much deeper into EPR but let's say

you had a $400,000 you had $400,000 to

pay cash for your $400,000 house you've

got no debt and you're in a thirty four

percent tax bracket so you're six and a

half percent mortgage has an EPR of 4.2

nine percent and let's assume that

you're the epr on your investments is

six point five percent so that means

your after-tax return on your

investments is six point five percent if

you then invest that $400,000 earning

and after tax six point five percent

you're actually earning two thousand one

hundred and sixty six dollars and 67

cents per month and having a mortgage

with a four point two nine percent APR

means you're paying one thousand four

hundred and thirty dollars a month now

that gives you a positive income of

seven hundred and thirty six dollars and

67 cents so if we look at that over a

thirty-year period and assuming you kept

earning six point five percent in that

investment lets you know what let's even

go so far as to say that you invested

your cash flow that's seven hundred and

thirty six dollars and thirty seven

cents you invest that cash flow every

month earning just six and a half

percent after-tax for thirty years well

folks that gives you eight hundred and

fourteen thousand five hundred and fifty

six dollars an additional wealth

now so using conservative numbers you're

losing over eight hundred and fourteen

thousand dollars or more than sixty

seven thousand dollars per year by

paying cash for your house we refer to

this as the transfer of wealth that

happens when smart people don't fully

understand money now if you're worried

about the payments or that you have a

mortgage on the house you still got the

four hundred thousand dollars to pay the

loan off if you want but why in the

world would you want to because your

money is paying your mortgage and paying

you seven hundred and thirty six dollars

and thirty seven cents per month see

what we found is that when folks

understand how money actually works for

them they stop worrying about having a

mortgage and they end up basking in the

glory of knowing that they are being the

banks at their own game

now this is where we're going to go onto

the second section or the second video

of this so please just click on the

video that's shown below here on the

screen just scroll down in scope and

click on it and you will have part two

of this video series about why would you

want to pay cash for your house