Get the best loan terms in a tough lending environment
Short term Interest Rates are currently at 0%, unemployment is near 10%, the Federal Reserve is printing billions of dollars in an attempt to devalue the dollar and push up asset prices, so businesses can export more goods overseas and consumers will feel wealthy enough to spend again. The Fed is using the printed dollars to buy long term US bonds to artificially lower long term interest rates in an attempt to spur economic activity and pump up the housing sector. The only problem is the economy is crawling along, there is no velocity in the system, investors are hoarding cash, and banks are not lending.
Given the timeliness of the Fed’s “quantitative easing” policy, I believe a unique situation exist for business owners with strong balance sheets to use their home like an ATM, defying conventional wisdom and borrow the maximum allowable against their personal residence to insure the business has access to low cost capital under significantly better terms than the business could get from traditional sources. By executing a 30 year cash-out refinance mortgage you could lock in long term borrowing at today’s effective interest rates of 3.5% – 5% (net of tax), which are the best interest rates and terms and conditions ever offered. While the idea of actually executing a cash-out refinance in place of conventional business financing might feel emotionally repulsive, it holds the potential to, much like a bank, make money on the spread between borrowing cost and investment return. This is a smart way to create considerable wealth with little additional risk over the life of the mortgage term (30 years).
| The goal of owning your home free and clear by a certain date should in no way be associated with the length or amount of your home’s mortgage loan. By focusing on creating maximizing efficiency (the highest return with the least risk of loss), any wealth created can be used to pay off the home loan faster if that is the highest priority. |
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Logic vs. emotion
Many of the clients we counsel tend to view business assets differently than personal assets. Much has been written about how human emotions influence financial decisions and in study after study logic is rarely a match against emotion. The emotions surrounding home ownership are usually some of the strongest and often the most illogical. I’m well aware the reasons to pay your house off. It feels safe because no one can ever take your house. Plus, once equity is in your house it is locked away from other creditors. But, I would argue money tied up in equity is a dead asset growing at 2- 3% per year. What amount of money would you need to shift your paradigm about having a mortgage balance? Have you ever stopped to consider the opportunity cost of leaving the equity in your home at today’s interest rates? For most business owners their opportunity cost of capital is in the double digits and could amount to millions of dollars lost in their lifetime. If you were able to get better terms on your business debt, could you take a higher salary, put more money in your retirement plan, or even buy another CD.
Isn’t more liquid money the answer to having more security, more freedom, and more choices?
Only the future will tell how productive using a refinance to redistribute your wealth will be, but if it is possible to lock a 1% or greater spread on your money with very little risk today, imagine how productive it will be if rates on AAA municipal bonds go back to 7% or 8%, a very possible outcome given the US Government’s financial policy and deficit spending. Based on simple modeling, every $300,000 of debt accessed today could easily create from $500,000 – $1,000,000 of additional wealth (depending on your cost of capital. Let’s look at a real world example using today’s SBA rates for fixed financing:
Option 1: Use SBA fixed loan (7%, 25 year amortization for $300,000) and leave as is $300,000 in equity alone growing at estimated 2.5% home appreciation rate.
Option 2: Borrow $300,000 out of Home at 4.5%, 30 year amortization to fund the $300,000 business need (pay loan off in the 25th year (same as Option 1) Don’t use SBA Financing.
Cost of 7% 25yr loan = -$1,628,229
Cost of 4.5% 25yr loan = -$901,630
Difference in financing cost = $726,599
Difference in Payments $34,893 ($600/month at 6% 25 years)
Total Productivity over 25 yrs = $761,492
In this real world example the business owner could easily create almost a quarter of a million dollars in excess wealth by using a mortgage instead of higher rate business debt. While we understand that a home mortgage is often viewed as a sacred cow that should be left alone, for some this cow may need to be slaughtered. Business owner’s that routinely make in excess of $250,000 are going to be in Uncle Sam’s sights over the next couple of decades to help pay for more than your share of the deficit. The mortgage tax deduction is one of the last effective government subsidies available to the “wealthy”, and while it may be limited by income, it is still a legal tax deduction that can lead to significant additional wealth.
I’m not advocating that you take the money out of your home to buy a boat or other depreciating asset. What I am advocating is responsible borrowing to control the terms of your debt. Rely on logic, math, and current tax law to guide your decision making looking forward.