August 18, 2022

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Mortgage As A Forced Savings Account To Build Wealth

A forced savings account will help make you rich over time. It forces you to save versus relying on relying on your own discipline. A mortgage is exactly this, a forced savings account. Every month you pay your mortgage means a portion of principal gets paid down. This forced savings account builds you a ton of equity over time.

One of the main reasons why the average net worth of a homeowner is 40X greater than the average net worth of a renter is due to forced savings. People think they can consistently save and invest the difference while renting. The reality is, unless the savings is automatic, it’s hard to sustain the discipline.

Mortgage As A Forced Savings Account

Back in 2000, many investors were cocky, much like investors today with the stock market at record highs.

I remember asking my Director at the time what he thought about the concept of the mortgage as a forced savings account? At the time, as an investor, it appeared he could do no wrong.

He said, “I don’t need no forced savings account. Only irresponsible people who don’t have the discipline to save every month would consider their mortgage as savings. I’d rather have as big of a mortgage as possible so I can make money in the stock market!

My Director ended up losing millions when the dotcom bubble collapsed. He no longer looked down on people who slowly grew their wealth. At least, unlike most people, he had millions to lose!

If you have a traditional mortgage that pays down principal and interest, the mortgage “forces” you to save because you are forced to pay your mortgage every month if you want to keep your property. A percentage of each mortgage payment goes towards principal, which can be considered savings.

I’m also in the camp that it’s better for most people to receive a tax refund, even though it’s like giving the government an interest free loan, because most people can’t save for crap!

A Forced Savings Account Saves You From Yourself

After paying off $460,500 in mortgage debt in 12 years, I’ve had time to reflect on whether a mortgage can really be considered a savings account. If this rental property was all I had, I’d be considered “house rich, cash poor” because my ratio of home equity to liquid cash would be around 10:1.

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The reality is my physical property portfolio accounts for less than 40% of my total net worth if I exclude my online business. If I include my online business as part of my net worth, then property accounts for less than 25% of my net worth. Contrast this to the average home-owning American who has a scary 80% of net worth in property.

Let’s ignore my property’s appreciation over the past 12 years and solely focus on the $460,500 in debt I paid down compared to whether I would have been able to save $460,500 during the same period. The easiest comparison is principal pay off vs. 401k savings.

401k Versus Savings

If I maxed out my 401k from 2003 – 2015, I would have saved $204,500. That’s exactly what I did. Remember, the maximum contribution limit in 2003 was only $12,000 and slowly rose by $500 to $1,000 increments to the current $18,000 maximum in 2015.

Contributing to a 401k is just as easy as paying a mortgage once you make 401k contributions automatic. The money is deducted pre-tax from your gross income so the hit doesn’t feel as bad and you never see the money in the first place. The issue is, saving $204,500 in my 401k is still $256,500 less than the mortgage debt I paid off during the same period. Even with stock market returns, profit sharing, and company matching, my 401k only grew to a little over $400,000.

Where did the rest of the money go?!

This is the question I think most people have. We spend years making all this money and wonder why we don’t have much to show for all our efforts. Ever wonder where all the cash you withdrew from the ATM went? I do!

The simple reason for not being able to accumulate wealth as prodigiously as expected is because money is like water, and we’re a leaky ship sailing through an unpredictable storm. Something seems to always come up.

A Mortgage Is Dumb And Easy At The Same Time

A mortgage really does save people from them selves. I’m not sure if there is any better forced savings account than a mortgage.

Below is a chart that shows the value of a rental property I own and the mortgage value. Notice how the mortgage was eventually paid off about 12 years of ownership. I didn’t pay down too much extra principal.

Rental property mortgage amount and property value history from 2003 – 2015.

Most people responsibly pay their mortgages through the good and bad times. If you don’t, your credit gets crushed, you won’t be able to borrow at normal rates for years, and you’ll ultimately end up losing your downpayment and perhaps more if you purchased in a recourse state.

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Given the bottom 90% of Americans have had an average savings rate between -3% – 5% over the past 20 years, it’s clear that most Americans don’t have the capacity and/or discipline to save. We’re bombarded with aspirational ads that make us want to spend.

Further, we compare ourselves to our neighbors who make us feel less worthy unless we spend as much or more than them. Credit cards make instant gratification so much easier. And the vast majority of car buyers spend way more than 1/10th of their gross income on a car.

Saving money is hard because society makes spending so easy!

Of course there’s no free lunch given a mortgage requires an interest payment. But statistics don’t lie. The net worth of homeowners is multiples greater than renters partly because of the forced savings component of paying down principal. The other reason is obviously the appreciation of property over time, even if the appreciation is just due to inflation.

It’s hard enough to save an amount equal to the amount of mortgage debt being paid off. It’s even harder to save an amount equal to the total value of the property’s equity thanks to capital appreciation.

What started off as a $120,000 downpayment has now turned into a paid off asset that if sold, would provide over $1,000,000 in cash after commission. I almost don’t care about the 730% increase in equity from the initial downpayment. All I care about is that 12 years later, this property is a wholly owned asset in my portfolio.

Make Savings Automatic With A Forced Savings Account

The Average Net Worth By Age

Many renters like to tell me that they “invest the difference” by not owning. It’s a good idea in practice. Yet, we all know the temptation to splurge tends to derail us from financially wise decisions. A mortgage truly is a forced savings account that has helped many middle class people build wealth over time.

Whether you pay your mortgage, contribute to a 401k, enact a dividend reinvestment plan, or invest in an after tax investment account, make your contributions automatic. If they aren’t automatic, it’s just way too easy to cheat by contributing less or not contributing at all.

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A mortgage as a forced savings account is the best thing ever. It feels great knowing that usually within 30 years, you’ll have built up a tremendous amount of savings through home equity.

Invest In Real Estate More Strategically

Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile. 

The combination of rising rents and rising real estate prices builds tremendous wealth over the long term. Meanwhile, there are more ways to invest in areas of the country where valuations are lower and net rental yields are higher thanks to crowdfunding. 

Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore.

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. The real estate platform has over 300,000 investors and manages over $3 billion. 

CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.

I’ve personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000. 

Shop Around For A Mortgage Online

Check the latest mortgage rates online. You’ll get real quotes from pre-vetted, qualified lenders in under three minutes. The more free mortgage rate quotes you can get, the better. This way, you feel confident knowing you’re getting the lowest rate for your situation. Further, you can make lenders compete for your business. 

A mortgage is truly a forced savings account that will build you a lot of wealth over time. You just need to get the lowest mortgage rate possible so more of your monthly payments go towards paying down principal.