Retirement Simplified: Investing | Social Security | Taxes

Ryan Kolden:
If you're a homeowner and you have surplus cash flow each month, I'm going to show you a more efficient home loan that may allow you to pay off your mortgage in as little as 3-7 years and potentially save tens of thousands of dollars in mortgage interest. Welcome to Alternative Wealth, where we explore traditional and alternative investing, retirement, and personal finance concepts. I'm your host, Ryan Colden. Join us as we talk about the strategies and tactics that can help you make better financial decisions.

Disclosure & Disclaimer: Ryan Colden is an investment advisor representative of RPG Family Wealth Advisory. Colden Wealth is a DBA of RPG Family Wealth Advisory. The opinions expressed by the host and or guests in this podcast do not necessarily reflect the opinions of Colden Wealth or RPG Family Wealth Advisory. No information on this podcast should be construed as investment, legal, tax, or financial advice.

Ryan Kolden: So I want to start with a high level overview of the offset mortgage strategy and then I'll go ahead and dive into the finer details. And real quick before we get going, if you're getting ready for retirement and you want to see how everything's going for you, go ahead and check out my first step retirement planner. The link is in the description below. This concept is called an offset mortgage. And it's been around for quite a while, many decades actually, in countries outside the United States. For whatever reason, it's just never really caught on here in the US, but it is somewhat popular in countries such as Canada, Australia, New Zealand, as well as United Kingdom. An offset mortgage is probably the most efficient way to pay off your home as fast as possible, reducing interest to the maximum extent, all while offering you liquidity of the extra payments that you're making. And really, the only way to do something more efficient in the context of paying off your home, to do it more efficiently than the offset mortgage is really to purchase your home in cash, which isn't doable for probably 99% of the United States population. And the way that the offset mortgage works is by linking your mortgage account with your savings account. And what this does for you is it lowers the outstanding balance of your mortgage, which then in return allows you to save on paying mortgage interest. So instead of earning interest on your savings, so instead of money sitting in an interest bearing account and earning interest over there, What you're doing is instead putting your savings on top of a loan balance, a debt balance. And that savings is used to reduce the amount of interest that you pay on your mortgage because the balance is lower. And this is just a different way of earning interest. Instead of earning interest using money, what you're doing is you're recapturing lost interest that would be paid to somebody else. So rather than earning money on your savings, you're reducing the amount of cash that is leaving your hands. Again, reducing the amount that's going to somebody else. Now, the amount of savings that you allow to sit atop of your outstanding mortgage balance is what acts as the offset against your mortgage. Hence the name of the concept, offset mortgage. So for example, if you have a $400,000 mortgage, and let's say you also have $100,000 of savings. What you do is you let that $100,000 sit on top of the $400,000 mortgage. So instead of paying interest on all $400,000 of that mortgage, what you're doing is in effect artificially lowering the balance of the loan. to $300,000. So what you end up doing is paying a balance on $300,000 or interest on $300,000 versus $400,000. Now, in terms of your monthly mortgage payment, it actually remains the same with an offset mortgage. But the amount that you pay towards interest is going to be less because your savings are reducing that outstanding mortgage balance, which interest is calculated upon. Ultimately, this leads to greater principal payments, which means you pay off your mortgage significantly faster than you would with a traditional mortgage. Now, because your bank account is linked to your mortgage account, the savings component of the offset mortgage is still going to be accessible to you in the event that you need it for, let's say, an emergency that pops up. However, you just need to be careful and understand that when you take savings out of the offset portion or your savings component, what you're doing is in effect increasing the balance on the loan, on the mortgage. So you're basically drawing on the mortgage, you're drawing on the balance of the loan, which increases the amount that you owe, which then in return increases the amount of interest that you pay each month. So to quickly recap, an offset mortgage strategy can work very, very, very well for individuals that have a substantial amount of savings each month, about 25% more than your expenses. And really, anybody who's considering to pay off their home as fast as possible, while mitigating the amount of interest that you're paying, this is something that is probably worth their while to consider, right? But again, it all depends on what you're trying to achieve financially and your unique financial goals. It's a flexible approach that can potentially save a ton of money and shorten the time that it takes to pay off a mortgage. So that's it from a high level view. And now I want to dive into the more granular details. But before I do that, we kind of have to talk about and be clear about who is a good fit for this and who is not. So to start, I really like to think about this strategy as being similar to how a credit card works. And just as a reminder, in case you don't know, the way that a credit card works is that it's an open-ended revolving line of credit. And as we know, when you pay with credit cards or with credit cards in general, if you pay off your card in full each month, you don't get charged any interest. And if on the other side of that spectrum, if you spend recklessly, you don't pay your cards off, you can actually run the balance up quite high. And the higher the balance, the more interest you get charged. So this strategy is similar to that. And because of that, this concept is only going to work for people who are fiscally responsible and disciplined with their money. Additionally, at the end of the day, paying off your home, regardless of whether or not it's with this strategy, traditional mortgage or any other type of way to pay off your home quickly, like biannual payments, extra payments, whatever it may be. It actually requires you, and I know this seems like a radical concept, to save money on a monthly basis, to have more income than what's leaving every single month. You have to have a net positive cash flow. Money just cannot be created out of thin air unless you happen to be the Federal Reserve. And this strategy is only going to work if you have a monthly surplus of about 25% or greater. So just as an example, let's say that you have $10,000 of monthly expenses. This means that you need to have an income of at least $12,500 each month in order to make this work. Now remember, it's not the exact number, it's just that surplus. So in this example, we have $12,500 of income, $10,000 of expenses, we meet that 25% minimum surplus. And All we're doing is we're taking that difference between our income and expenses, and that's our savings. And what we're doing is applying that savings to principal paydown. And that's it. That is the portion that contributes to principal paydown early. Now, to dive into it a little bit in greater detail, in the United States, we actually don't have offset mortgages, but we're able to replicate the same exact strategy or the outcome of an offset mortgage, which is saving on interest and paying off a home substantially quicker. And we can do that by replacing our mortgage with an open-ended line of credit. And you're probably familiar with home equity lines of credit. which is a very, very common way that people can use equity or access equity in their home to use it as cash. And people use HELOCs for all different kinds of things. Things such as home improvements, consolidating debt, and even sometimes in the case as an emergency fund. The thing with HELOCs is that people usually are only familiar with second or third lien HELOCs or position HELOCs, which means that it sits behind the home mortgage, their first mortgage, right? So the first part of this strategy involves replacing your traditional mortgage with a unique type of HELOC. And I want to issue a word of caution that it's very important that you work with someone or a lender who knows how to do this, because you can actually leave yourself in a worse position than you started. Again, going back to who this is not a good fit for. This is not a good fit for people who do not have their financial house in order. It's not enough to change the structure of our mortgage. We need to know why doing this allows us to pay off our home faster. And that way we can maximize the strategy and prevent making stupid mistakes using the strategy. The first thing we need to understand is how interest is calculated on both a traditional mortgage as well as on open-ended lines of credits, HELOCs specifically. So people think that the interest rate is the only thing that matters when it comes to loans. And that's true to an extent, but it's not always necessarily true. What matters more than the interest rate is the volume of interest paid. At the end of the day, the only thing that matters is the amount of money that leaves your pocket or stays inside of your pocket. So what I want you to take away is that the way your loan calculates interest can affect how much interest that you pay, not just the interest rate. It's actually possible to pay off a loan faster and save more interest utilizing a higher rate open-ended line of credit structure than it is with a lower rate traditional mortgage. Now, but just like everything in life, context matters and ultimately, whether or not you pay off a home quicker or faster with the structure that I'm talking about versus a traditional mortgage, it's gonna come down to your unique situation, your unique circumstances, and making a decision of what is best for you. By no means am I saying this is superior, right? It works very, very well and can save a ton of money in time. However, again, it's all gotta be correct for what's going on with you. Now, the way that the traditional mortgage calculates interest is by using amortized interest calculation, which uses your previous month's balance to calculate your next month's payment. It's said that mortgage interest is front loaded, and this is factually true, but it doesn't necessarily mean that a mortgage and the way it calculates interest is either good or bad. It's just the way it is. The front loaded nature of a traditional mortgage is due to amortization, which means that a larger portion of your monthly mortgage payment is going to go towards interest at the beginning of the loan compared to a principal. And when you take out a mortgage, your lender creates what's called an amortization schedule that outlines your monthly payment over the terminal loan, which in the United States is most commonly the 30 year fixed mortgage. That schedule will detail how much of each payment goes towards interest and how much goes towards reducing the principal balance. Initially, the principal balance is as high as it'll ever be, right? So if you take out a $400,000 mortgage, the principal balance on day one is going to be the highest that it ever will be $400,000, which is the full amount of the loan. So although the interest rate remains fixed throughout the loan, you know, in the case of a traditional fixed mortgage, interest calculated on the higher balance at the beginning of the loan term is going to be greater than on month 359 at the end of the term, right? So as you make monthly payments, a portion of each payment goes towards reducing the principal balance. And with each payment, the remaining principal decreases, which in return reduces the amount of interest paid on subsequent payments. Now, because more of your initial payments goes towards interest rather than principal, building equity in your home is slower during the early years of the mortgage. Now, every mortgage is structured just slightly differently, but generally speaking, during the first year of a 30-year mortgage, a 30-year, you know, traditional fixed mortgage, approximately 70 to 80% of your mortgage payment goes towards paying interest. while the remaining 20 to 30% goes towards building equity or principal pay down. Now, with a mortgage, on average, I would say it takes about 13 to 15 years to get to the point of the amortization schedule that the ratio flips in your favor, let's say 50-50. And then from that point on, you're paying more in principal than you are in interest until the balance of that loan is zero. Now that we understand that, Think about every time you move homes and enter into a new mortgage or you refinance your existing mortgage. What you actually do is start this entire process over again, going back to square one where you're paying more in interest than you are in equity. Now, this isn't always the case. There are some very rare exceptions to this. So for example, if you're able to recast your mortgage, which is an option for you, or maybe let's say you have a rental property and you want to do a cash out refinance. where it makes sense to possibly do the cash out refinance and reducing mortgage interest may not be a priority for you. But you can see refinancing your mortgage and moving around may hurt your ability to build equity in the long run. Now, onto HELOCs. The way that HELOCs calculate their interest is different than with traditional mortgages. HELOCs instead use the average daily balance to calculate interest payments. And the way this works is your interest payment is calculated daily using that day's outstanding balance. So if you can decrease the balance on a daily, weekly, and monthly level, your interest payments will be decreased overall. So I've talked a lot about how all of this is possible and just kind of like the principles behind it. But now I'm going to explain how this works in just a few sentences. The HELOC structure is going to completely replace your mortgage. Once it's in place, you no longer have mortgage payments. And instead, it's going to be replaced by the HELOC monthly payment, which is only interest only. That's a weird way to say it's an interest only payment. your initial payment due is going to be slightly higher than your traditional mortgage payment. But each time that you contribute towards principal pay down, your next interest only payment is actually going to be lower than it was for the previous month because you're now paying less interest on each subsequent payment as you pay the balance down. Now, All you do, like the mechanics of the way that this works, all you do is deposit 100% of your monthly income into your bank account, which is linked to your HELOC balance. What that does in effect, the HELOC is gonna reach over and grab the money that's deposited in your bank account, and it's gonna reduce your balance. When it's time to pay your monthly expenses, you draw upon the HELOC. To give you a quick example to kind of like tie this all together, let's say that you had a $200,000 balance on your HELOC. You know, you've replaced your $200,000 mortgage with a $200,000 open-ended line of credit. And then let's say you have $10,000 of income after taxes. So $10,000 goes into the bank account. And let's say you also had $5,000 of expenses. So again, $10,000 is going to flow into your bank account on day one. And that $10,000 is going to go sit on top of the balance of the HELOC. And we said the balance was $200,000, right? So once the $10,000 goes on top of the $200,000, the balance of the HELOC goes from $200,000 down to $190,000, a reduction of $10,000, which was equal to our income, right? Now, I also said that we had $5,000 of expenses that are going to happen throughout the month. Let's say that we're able to put all $5,000 of expenses onto a credit card, And on the last day of the month, which is day 30 of the month, you withdraw $5,000 from your HELOC to pay your expenses. Therefore, the balance of the HELOC goes from $190,000 and it's going to go up to $195,000. That month you paid interest on a balance of $190,000 rather than the $200,000. And then the next month, this process is going to repeat itself, except instead of last, the previous month, we started at $200,000. This month, we're starting at $195,000. So this time when the $10,000 comes into the bank balance and sits on top of our HELOC, we're going to go from $195,000 to $185,000. And that's it. That's the strategy. So in this example, we had a surplus of $5,000. So we're paying on average. an average monthly principal pay down of $5,000. And just a quick note, again, that strategy also kind of hinges on the ability for responsible credit card usage. You don't have to use a credit card, but if you want to maximize things, you can. And just understand that you don't get charge interest on credit card if you pay it off before the billing statements do or the end of the billing cycle. if you paid off within 30 days. So just remember to pay down our mortgage as fast as possible. In order to do that, it requires us to dedicate 100% of our surplus savings to principal pay down. This means that all of your income must be routed to the offset mortgage, to the HELOC, to reduce your principal balance as much as possible. In return, this is going to maximize your interest savings. So let me walk you through another quick example. Let's say that you have a married couple and they have a $400,000 mortgage. And let's also assume that on a monthly basis, they take home $15,000 a month after taxes. And let's also say that they have $10,000 worth of expenses, which includes everything, even the mortgage, right? So this means that they have a surplus on a monthly basis of $5,000, $5,000 that they're saving each month. And what they want to do is to use it to pay off their home as fast as possible before they go into retirement. So how long is it going to take to pay off their mortgage using this concept? Well, we can get an exact number, but we can also just use a simple estimate by taking our mortgage balance, our outstanding mortgage balance, and dividing it by our monthly surplus. So that's $400,000 divided by $5,000 for this example, which gives us about 80 months. I don't know why I said it gives us about, it gives us 80 months. Take that number, so take 80 and divide it by 12, which is gonna give us, convert us from months to years. And that gives you about six and a half years. So it's gonna take them about six and a half years to pay off their 30 year mortgage. which is about 23-24 years ahead of schedule. And depending on the interest rate environment, so right now interest rates are a lot higher than they were three, four or five years ago, as well as the terms of the original mortgage, the difference paid between a traditional mortgage and the offset mortgage concept that we're talking about right now, it can potentially be an incredible sums of money. And by no means am I advocating for you to stop saving and investing for retirement. Whether or not this strategy is something that you you should consider is going to ultimately come down to your overall financial goals, as well as your unique situation. And generally speaking, since this strategy requires you to put 100% of your income into the HELOC structure, the open-ended line of credit structure, you do have access to it, which means it can also dual purpose as a source of emergency funds, while allowing you to reduce the cost of interest paid over the life of the loan. So now that we've covered how traditional mortgages and HELOCs calculate interest, the next thing that we need to cover is why the open-ended line of credit structure is superior to other forms of paying off your home early. Now, some other common ways of paying off your home early include extra payments on an annual basis. A lot of people do bi-weekly payments. which is another common form, recasting, refinancing, as well as adjustable rate mortgages are all different ways that people can save on either interest or pay off their home earlier. And all of these methods absolutely work to pay off your mortgage faster, as well as saving interest. However, the major limitation of these methods is ultimately what comes down to flexibility. Flexibility specifically in managing your cash flow. With each extra payment that you make with the methods I just described, with traditional methods, what you're doing is locking away your money in your home's equity. And the answer is, yes, you can use any one of the methods I just described to pay down your mortgage. But if you have the additional surplus savings required, and again, that's a huge part. This strategy doesn't work for everybody. You have to have a 25% surplus. So that's another reason why you may want to use those other types of paint on your home rather than using this. But if you did have additional surplus savings, then why would you want to use any other structure than the HELOC structure? With an open-ended line of credit, money can flow freely into or out of the line of credit, so there's flexibility and there's access to your money. If you were to put in 100% of your paycheck into one of these other traditional forms like extra payments, you would lock it all away and be unable to tap into it. And unless you refinanced your home, which can take a little bit of time, a little bit of time to do it as well as be costly, refinancing your home isn't something that you can do every day. So that's why you can't use extra payments to put 100% of your surplus savings into a mortgage. It's simply not financially responsible. To summarize everything that we went over today, we can actually use a home equity loan to replicate the concept of an offset mortgage, which allows us to pay off our home in a very quick amount of time while saving a ton on mortgage interest. The HELOC operates like a revolving line of credit, allowing you to put 100% of your excess savings into the balance, which offsets the mortgage, so to speak. It reduces the amount of interest that you pay over time, which in return shortens the life of the loan. If this is something that you're interested in or you want to see if it would work for you, then go ahead and book a call with me. The link for that is in the description as well as the pinned comment. On that call, we'll go ahead and run your numbers and give you an estimate of how quickly you can expect to pay off your home and idea of how much interest that you could potentially save. And that's a wrap for today. If you enjoyed the video, please like and subscribe. I'll talk to you next time. Take care. The opinions and views expressed here are for informational purposes only and is not tax, legal, financial, investment, or accounting advice. This material is educational in nature and should not be deemed as solicitation of any specific product or service. All investments involve risk and a potential for a loss of principal. Should you need such advice, please consult with a licensed financial, tax, or legal professional. Neither host nor guest can be held responsible for any direct or incidental loss incurred by applying any of the information offered.