REAL ESTATE - Scam which generally takes very long time to expose

Updated: Sep 10

Unless and until you sell it on wrong time you don't understand this scam.


It's a popular opinion in society that real estate is one of the safest form of wealth accumulation.


Yes correct, if you or your father took decision on right time and no Black Swan event occurs.


No wrong if you or took decision on wrong time and some Black Swan event occurs.


But it sure does help things along — if you do it right. Unfortunately, most people don’t.


Let me see if I can give you a different way to think about home ownership.


Imagine you’re 25 years old. You’re done with school, finally working in whatever your field is. You aren’t making anywhere near the money you want to be making yet, but you’re on track. You have some savings and feel pretty stable. You’re thinking about buying house.


So, you go to the bank and figure out how much house you can afford. They tell you they’re willing to write a mortgage based on a total payment (including taxes and insurance) up to 40% of your gross monthly income.


This is where most people mess up.


MISTAKE #1 is when people “shop by payment” and buy the most expensive house the bank says they can afford, without thinking about how long they’re going to be paying for it for or how much debt they’re taking on.


MISTAKE #2 is that most people are still getting a 25 to 30 years mortgage, which is the absolute worst way to buy a house. Banks always push for the 30 years because it’s where they make the most money and because they know most people are focused on payment instead of price. A lot of people rationalize it by saying “I’ll just make extra payments” but fewer than 2% of borrowers actually do it in the real world.


MISTAKE #3 is that some point along the way, most people will refinance and start the loan over for another 30 years. This is the worst mistake of all.


Let’s just look at some real numbers for a minute. Assume you’re mortgaging $250k and your base payment is about $1,122 per month. In the real world it would be a little higher but I’m leaving out taxes, insurance, PMI(Private mortgage insurance), HOA(homeowner's association) fees, etc so we can focus only on the principal mortgage and debt.


Fast forward a bit and pretend you’ve made that payment every month for 10 years. At the 10-year mark, you’ve given the bank $135k worth of payments, but more than half of them — about $77k — was pure interest. You still owe the bank $192k. And on top of that, you still have another 20 years to go. By the time you pay that house off, you will have given the bank more than $400k for a $250k house. This is illustrated in below example.

Compound Interest Amortization Schedule
Image by Author - Compound Interest Amortization Schedule

Interest vs Principal
Image by Author - Interest vs Principal

That’s insane.


People rationalize it by talking about appreciation, but if you really do the math, you aren’t getting that appreciation — the bank is. Well, the bank and the government due to property taxes. Outside of a handful of real estate markets, most houses don’t appreciate at an annual rate that’s higher than the property taxes + interest.


So now let’s look at the same scenario but on a 15 year mortgage. Same $250k borrowed. Your payment will be a little higher — $1,787 instead of $1,122 — but the long-term math looks very different. At the 10-year mark, you’ve given the bank $214k, but you only owe $92k instead of $192k, only paid $56k worth of interest, and only have five years to go instead of 20.


Let me say that again…


Your house will be completely paid off in five more years. You will never have a house payment again. If you started when you were 25, your 40th birthday present to yourself will be a fully paid off house.


How many 40-year-old’s do you know with a paid off house? Probably not many. Most still have 20 year worth of payments left on their mortgage. Heck, if you had a kid right around the time you bought your house, you would be living in a paid off house before they finished high school.


Think about where you’re going to be in your career path at age 40 vs age 25. You’re probably established. You’re probably making a lot more money. You probably have some investments, some savings, and a decent retirement account going regardless of the house.


But now, on top of all that, you have no house payment. What do you think your savings account and those other investments are going to look like in a few years when you can start throwing your house payment into that pot every month? Fast forward another ten years and you could have a $500k+ investment portfolio just from what you used to throw at your house payment.


Plus whatever your house itself is worth.


By the time you’re 50, you could easily have a net worth north of $1 million while all of those chumps who did a 30-year mortgage or refinanced along the way are still paying back the bank…

Home ownership can be key to wealth accumulation, but only if you actually own it. If the bank owns it, you’re just giving your money and your equity to them. When you stay in debt, the bank is the real winner. Why do you think they advertise refinancing so aggressively? It’s because it lets them start the loan over and keeps your money flowing into their pockets.(Illusion of Free will) Don’t fall for it.


“Compound Interest is the eighth wonder of the world, he who understands it, earns it; he who doesn't, pays for it.” - Albert Einstein


“The first rule of compounding is to never interrupt it unnecessarily.” - Charlie Munger


Eighth wonder of the world - Compound Interest
Image by Author - Eighth wonder of the world - Compound Interest

Don’t buy the most expensive house you can afford, don’t get a 30-year mortgage, and don’t ever refinance to “pull out cash”.


Stick to a reasonable house price relative to your income and a 15-year loan. The sooner you’re “living rent free” the sooner you can start really growing your money. That’s how you win.


Thanks for reading…


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