HMW #130: Why Rich People Don't Have Paid Off Properties

 Read Time: 7.25 minutes

Our favorite sponsors who help keep this content free for you:

Today's issue is sponsored by Jasmine Mortgage Team my preferred residential lender. My team and I have done over 83 deals directly with Jasmine and her team. Work with someone that understands real estate. Book a free 15-minute consultation with Jasmine today. 

And Steadily Landlord Insurance, the premier insurance company for landlords of all types. Landlord insurance created by landlords offering dwelling, umbrella, builder's risk, renters, flood insurance and more. Whether you have short-term or long-term rentals, student housing, vacant properties, or other investment needs, Steadily offers fast, affordable insurance quotes.

Congrats! You have almost paid off the mortgage on your property and you are on Cloud 9. This is the "Dave Ramsey method" to riches and the goal of many new investors that can't wait for that day to come where their mortgage balance is zero.

But I'm going to let you in on a secret. This is not what rich people do. The majority of billionaires in the US have a mortgage on their property. (I, Alan, have helped a few as a realtor.) The only one I've found that doesn't is Warren Buffett, who lives in a house he bought in Omaha for $31,500 decades ago.

Billionaires can easily pay cash for their real estate, right? So, why do they get mortgages? Why did your rich neighbor do a cash-out refinance on their rental property recently instead of just collecting all that sweet cash flow?

I'm going to break down 4 mind-blowing reasons why paid off properties are not the goal of the rich, and have you question your devotion to the popular talking heads of personal finance you see on TV all the time. Are you ready to find out there are possibly better things to do with your home's equity?

I know it seems that it may all be BS. I get it. I used to be brainwashed by Suze Orman with the same no debt wealth building tactic until I learned what most rich people actually do with their real estate. Let's dig into the 4 reasons why they love mortgages on all their properties!  

Reason 1: They can put the money to work in better ways

If you have a paid off property, the only money you are making from it is cash flow and whatever equity is created as the market moves up and down. But rich people see they can make money in 3 different ways with real estate. They will do a cash-out refinance on a property by getting a 30-year mortgage on it.

With a cash-out refi, they still make money when the market moves up and equity increases. That money-making opportunity is not lost with a mortgage. If a $100,000 house is in a market that went up 10% in the past year, they still made $10k with or without a mortgage.

With a cash out refi, they still cash flow, although not as much each month as they have a mortgage expense now. But they aren't paying that expense, their tenants are and will until the mortgage is paid off again.

And lastly, and most importantly, the third way a rich person can make money is re-invest the cash out finance proceeds. Let's say they get $70,000 cash from a refinance on their $100,000 property at 6.5% interest. 

They will find a way to invest that entire $70,000 into something that makes them 8% or more each month. Maybe they become a hard money lender for someone else or invest in a business. Or get historical 8% returns in the stock market. But they are in the business of leveraging money: borrowing it at one rate (6.5%) and lend it out or making more money in returns at a different higher rate (8% or more). And they keep that 1.5% spread. But often that spread is actually 5-10% based on their investment savvy and connections. 

Ok, thought you might. But just in case you need more reasons to cash out refi, consider these other two reasons.

Reason 2: Inflation Hedge with fixed expenses

I cover this is detail in my blog post here, but if you have a lot of money and there is a lot of inflation that you have no control of, your money loses value just sitting in the bank.

So to protect that money from losing value, you lock in its value with a 30-year fixed mortgage. That way if a dollar loses its purchasing power in the real world, it actually stays the same in all your fixed debt costs. A dollar in the real world will not be worth as much as you try to buy gas or groceries in 10 years time. However, a dollar paid to your mortgage balance in 10 years is still worth a full dollar off the amount due.  

Mortgages help real estate investors and rich people protect their wealth long term.

Imagine you took that $70,000 cash from the above example and used it as a down payment on a $300,000 property. That would require a $230,000 loan. 

Now you have just protected $300,000 from inflation ($70,000 from property 1 and $230,000 from property 2) when before you had no inflation protection. This is how rich people think. 

But let's take it one step further as it doesn't just protect their wealth, mortgages can also create more wealth for you.

Let's assume that in 10 years your property values go up 10%. You just made an extra $30,000 from getting a cash out refi and then using it to get another mortgage as your new property is now with $330,000. You would not have made that extra $30k by keeping your property paid off in cash.

Reason 3: A mortgage reduces your chance of getting sued

Lawyers love suing rich people. That's where the money is. Imagine a situation where a tenant wants to sue their landlord for $100,000 and that landlord has a $100,000 paid off property in an LLC. 

An attorney knows that if the tenant wins, that owner can be forced to sell the property to pay off the damages demanded by the court. But what do you think happens when the same situation when the attorney sees there is a $70,000 mortgage note on the property?

The attorney says there is only $30,000 of equity we can go over in the case if we win. And maybe the tenant decides not to sue or sues for a lesser amount. 

Rich people know that a mortgage is excellent asset protection in lawsuits and try to get as much debt as possible to give them extra peace at night.

Well to the rich it is! Maybe it should be for you too.

Reason 4: Cash-out refinances are tax free

The biggest and main reason is super simple: to access your equity you can either sell your property or do a cash out refinance.

A strategy of holding a property forever, tenants paying down the mortgage, doing a cash out refi, and then repeating is a wonderful way of creating a windfall ATM for any long-term investor. Cash out refinances are tax free gains that can be claimed over and over. If you were to sell an asset to access the equity that is in it, then you have to pay a lot of taxes that way, and who likes to pay taxes?

Oh man! I just made you agree with Donald Trump on something.

Summary

• Catch-all advice like paying off your mortgage is short-sighted
• Rich people use money as a tool and find ways for it to make more money
• Fixed-rate 30-year mortgages help protect against interest rate swings
• All debt has some risk but using it wisely and efficiently will make you more money in long run