If you where to build a new home and could either sub it out or get a contractor to do it at a reasonable price and you positioned the home in the appropriate area and did your homework on the comps etc…you could ostensibly get into the home w/ say 100k in equity. I know for a fact it can be done in my area b/c I’ve done the financing on some of them and seen the plans, specs, sub-to appraisals etc…
Now, lets say you build the house for 200k + 100k lot, you’ve got 300k in it but lets say it appraises for 400k day after completion. Now lets say you refinance it and get 100k cash out in equity. ( yes, there are lenders that will do 100% cash out w/ no seasoning on title). Now lets say you put the 100k in an account and set up your monthly payment to autodraft bi-weekly. You’re basically making your house payment off of the created equity. Now lets say you take your regular mortgage contribution of 1500.00 and apply it to principal every month. It would look something like this:
400k loan amount at 8.5% = PI payment of 3075/month / 100k lasts you 32 months.
You also make 2000 principal reduction payment every month((1000 every 2 weeks)). (What you’re normally used to making for a house payment)
After 32 months / 12 months in a year 2.7 years x 26 payments in a year(biweely) you would run out of money in 71 payments. Your balance after 71 payments at biweekly + 750 ever biweekly period will be $291,900.00.
Now you do it all over again. borrowing agian 100k back to 391,900.00 + closing costs, so lets say 395k. repeat. then when the money runs out do it again, but this time borrowre only 50k in cash out.
then do it again at 50k cash out.
after about 7.5 years still using the 8.5% rate you’ll only owe 189k on a house this is by now worth probably 500k. In any case you could be out of this house f/c in 15 years. THis method afforded you the opportunity to live in what will be a500k house, which in area is a 4000sq custom brick home…easy. By subsizing your payments w/ the equity you can live in a home you otherwise would have never been able to afford an pay it off in 15 or less years.
This assumes you pay your tx and ins. out of your own pocket.
Is my logic flawed here? By the way, you’ll need access to an amortization schedule that will compute biweekly paymens AND take into account the extra montly paymens of 1000 every other week or 2k/month. I’m using Calyx to do it, but you may can find something on the internet to do it…
you’re using borrowed money to make the payments on borrowed money, not a good fiscal policy. i would suggest running your numbers with the original $300k loan, bi-weekly payments and throw a little extra principal in for good measure and you will payoff the note in less than 15yrs. don’t overcomplicate the situation with the extra borrowed funds.
not to get off subject, but isnt that what corporate america does everyday? borrower money by issuing debt and or equity securities to finance projects and/or payoff other debt? maybe I slept in that corp. finance class, but that’s pretty much how the economy works…ie…public traded companies…federal govt. etc…
anyway, it’s a subsidy of sorts…if you have an understanding of loan amoritization you’ll see that the subsidy (payments from the created equity) allow you to make the PI payment due on the loan, mean time you’re contributing every month on the same biweekly schedule to principal only. The subsidizing via the created equity allows you to accelerate the am. schedule much faster then you normally would, even though you have to start further back…ie…borrowing more money to do it. If you look at my am. schedule and a normal am. schedule, my plan is much further along in the same period of time and again you get to live in a home that you otherwise wouldnt be able to afford. And infact you could say, what if I borrowed that same money (equity) and invested it rather then subsidize the loan payment, but then that begs the question could you really afford the payment w/out the subsidy. the answer is typically no, but if you could you wouldnt be doing this in the first place.
actually you did miss the whole point. you have to understand how amoritization works. for example, I borrowed 100k in “created” equity, and used it to subsidize may payments. so in about 3 years that same 100k is back in the home…(never lost it) and I’ve spent 71,000 out of my pocket.
conversly, if you followed a standard monthly principal and interest payment schedule on the same loan, after the same 71 biweekly payments your balance would be $286,231.00. that is $5669 less, HOWEVER, you total payin at that point out of your pocket is $81,888.00 or basically 10k more to gain 5k more. So you just wasted 5k and lost on the tax deductions that you could have had. Furthermore you get the intrinsics…you get a home that you othewise could not have bought and again conintuing my cycle, your out of hte house in 15 years or less, which you typically also would not have been able to do.
Trust me, I’ve ran these numbers a hundred times. If any of you that read this post have access to calyx you can run them yourself and see.
Sure corporate america borrows money every day but companies only survive when they generate a return on the borrowed money which is greater than the cost of borrowing. This scheme fails this test as you are borrowing money at 8.5% simply to repay other borrowed funds also costing 8.5%. On the surface this might seem a breakeven situation but it is not as the $100k is outstanding from day one and costing you 8.5% while the accelerated principal reduction scheme slowly builds from $0 on day one.
In this scenario you borrow $400k at 8.5% and make bi-weekly mortgage payments plus additional principal of $1,000 per month. After 71 payment periods you have a loan balance of about $295k and you will have paid about $40k in interest. If you simply borrow the original $300k at 8.5% and make bi-weekly mortgage payments and $0 additional principal payments at the end of 71 payment periods you have a balance of about $250k and will have paid about $32k in interest. The $8k of additional interest paid is the cost of following this scheme and borrowing the extra $100k. This is not a prudent choice.
actually, you completely dont get it and your math is way off.
In my scenario after 71 payments you’ve paid you’ve paid 71, 000 in principal reduction and owe 261,986.00. Never mind the other payments, b/c they where made for the created equity (the 100k you borrowed). That is money that you didnt have to work for…and otherwise wouldnt have had. The only money you spent that you actually went to work and earned is the 71k.
Now on the traditional loan, not borrowing the 100k, you finance 300k making a PI payment biweekly. After the same 71 payments, you’ve spent (out of your pocket/money you had to work to get) $81,888.00. So using traditional way, you spend 10k more “out of your pocket” then using my way. The balance by the way is 286,231.00. So not only did you spend more out of your pocket, you’re 15k behind my way.
Remember the 100k is just acting as a subsidy, your’re getting it back through paying it in. It’s just equity shifting…It allows you to sock money to the principal that you normally wouldnt be able to afford to do and thus accelerate the amoritization of the loan.
Can you send me your excel spreadsheet you are working with to run your numbers? I want to check them out and work them.
Also, depending on your income bracket, paying that extra interest on another loan could be helpful with the taxes at the end of the year, so I guess you would have to compare to your own situation.
You’re right on the extra interest. just to be clear, I was talking about doing 1 loan at 100% loan to value. you build for 300k and take out a loan right away for 400k. I’ll email the amoritization schedules.
by the way there is a small variance in my numbers b/c I originally ran them using a 1500.00 monthly (750 biweekly) contribution to principal and later upped it to 2000/month or 1k/biweekly. *********you have to do it biweekly to work, so when your drafted payments come out you have to also send in the 1k to get the full effect.
In the long run you will have to come out of pocket more to get the house paid off. You are borrowing an extra $100,000 and paying interest on it. Everytime you do that, it costs you more $100,000 + the interest to pay it back off. Unless the combination of the tax savings on the interest and the possible return from investing the $100,000 is higher than the rate of interest you pay( which is called arbitrage and is exactly what you are thinking that the “big boys” do ), then you will always end up paying more, because of the interest expense.
400k loan amount
8.5% interest
PI payment: $3075.00
biweekly payment: $1538.00 (made from your 100k borrowerd money)
add a $1000.00 principal reduction payment on same schedule as the biweekly payments. So, you’re spending 2k/month “out of your pocket”
the 100k runs out in 71 biweekly payments and your balance at that time is $261,986.00. v/s a balance of $286,231.00 on a 300k loan biweekly w/out making the principal reduction payments. …see my point…doing it under my “theory” will put you ahead. ****And more importantly, on my plan you’re spending 2k/month of your own funds v/s a PI payment of $2307.00 on a 300k loan. So not only would my way be saving you 307.00/month, you’ll be over 24k ahead…pretty cool huh…
on a 300k loan making biweekly payments at 8.5% you will pay it off in 22 years w/ a total payback of $671,216.64 principal and interest w/ $371,216.64 of that being interest. Now remember, that these payments where entirely out of “your” pocket…(not using the equity subsidy)
Now, w/ my method the interest on the loan is entirely subsidized by the equity that you continue to borrow. The only thing you ever make out of your pocket (money you made at work) is the 2k/month principal reduction payments. I ran this all the way down to $0.00 and following my pattern you would pay the loan off in 13.81 years w/ a total payout of your pocket of $373,000.00 in principal reduction payments. That’s a hell of alot better then paying back $671,216.64 out of your “own” funds (money you made at work), not to mention that you get done nearly 8 years sooner.
Remember, the money spent out of the equity subsidy doesnt matter, b/c that’s really not your money. You didnt go to work and make it doing your job. it’s “created equity” from a market value appraisal from market demand. I’m only talking in terms of the money you spend out of your checking account that you got paid for going to work every day.
by the way, I dropped to 50k cash out increments on refi number 3, finishing out w/ 6 refi’s and yes I factored in a nominal amoutn of closing costs for each refi.
I’m telling you this works! I’ve ran the numbers a million times…
if you ask how this could be, remember, loan amoritization on a simple interest loan is basically just like compounded interested on an investment or credit card…but just the opposite.
sky,
Thanks for providing your number details. After fixing my amortization schedule, which was in fact wrong when posted last night-sorry, I can replicate your $300k loan paydown details but not your calculations for the $400k loan repayment. Here is what I get:
$300k loan: biweekly payment $1,153 at 8.5%, balance after 71 payments is $286,231, total payments made $81,889, total interest paid $68,121.
$400k loan: biweekly payment $1,538 at 8.5% plus additional $1,000 principal per pay period, balance after 71 payments is $301,871, total payments made $180,198 ($71,000+($1,538x71), total interest paid $82,057.
Your results indicating a remaining balance of $261,986 seem too aggressive and lead me to believe there is an error in your numbers.
A smaller detail but still important is the burn rate on the $100k loan. You originally estimated the $100k will last 71 periods, but if you are making $1,538 payments each period from this loan then it will be exhausted in 65 periods. The difference comes from your original calculation ($100k/$3,075 = 32.5 months, 32.5/12=2.7yrs, 2.7x26=71). The calc starts with monthly amortization but makes the leap to biweekly amortization without adjusting for the two extra periods per year under a biweekly repayment schedule.
Forgive me for being ignorant here but I still don’t see where you include the 100K + interest payments being made. It would seem to me that this is money coming out of your pocket
I realize your looking at it as a separate loan but you got it exclusively for the property payments so it would seem to me that these payments have to be included somehow in factoring the payoff of the property.
You refi 6 times for $600,000 how does this factor in with its interest?
you’re correct on the 65 payments. I realized that later after posting. on the 400k there is a glitch…damn it…
I realized that my calyx origination software version has a glitch. I kept getting a payment that I couldnt figure out…anyway, I called tech support and the biweekly extra payment function is flawed. HOWEVER, while the numbers I posted earlier on the 400k deal are a little off, it will still work…
I just can’t give you exact figures right yet b/c my software has to be updated…waiting on the update patch as we speak…
anyways, It wont calculate biweekly w/ extra coorisponding payments…
I’ll repost it on here tomorrow w/ the new figures…