Dave Ramsey’s New House

Great article. I was referred to your blog after I forwarded a video about this for a guy I know who heads up another blog site. Dave Ramsey is mathematically challenged when it comes to mortgages. His advice makes money for ONE party…the banks! This isn’t theory or opinion but mathematical fact.

I’ll link to your blog post here in my upcoming series that I just started about the truths behind mortgages (Owning A Home: The Most Misunderstood American Dream – http://www.bethebank.wordpress.com). I do think you’d find this quick video about Ramsey’s purchase and math behind it interesting.

Here’s the link: http://www.screencast.com/t/BRsxcC6Tz

Kelly O’Connor
Financial Hero #2

Thanks for the reply Princess2221. Not sure where I forgot risk since Ramsey’s approach is mathematically the riskiest…which certainly doesn’t foster peace. The video is only the math behind paying cash…truly the most foolish financial decision one could make when buying a home (assuming they have the ability to do so). The worst decision is mortgaging a home you can’t afford but that’s not the situation nor the client I’m referring to here.

Also, the quote that 100% of foreclosed homes have mortgages is in fact true but a deflection of the point. This seems to then make the assumption that having a mortgage is always the wrong thing to do. Here’s how it should be stated: “100% of foreclosed homes are those with mortgages where the owner of the home had NO liquidity to pay the mortgage off.”

Paying off the home prior to “turning around and investing” only benefits the bank…this isn’t “peace” this is math. Plus, along the way, life happens. The assumption that you’ll even get to that point is a risk far greater than any stock or investment tip. Just ask some clients of mine whose house burned down here in Colorado or a client of mine whose house was destroyed in Hurricane Katrina, or several clients who lost their job but had the liquidity instead of the bank. Guess who weathered the storm? Those in control.

Ever wonder why banks offer a lower rate on a 15 year mortgage than a 30 year? Is it because they have your best interests at heart? No way. If they are in the business to collect interest then why would they offer you an incentive to pay less? Have you ever run the math that proves they make FAR more money on a 15 year than a 30 year? They get control sooner.

It is math. If you have control your peace is far greater than those who don’t.

It’s amazing how many people on Facebook have clicked the “Share” buttton!

Dave, you’re right about those who “fiddle with systems” and simply hope they don’t come crashing down; however, that’s not what I’m talking about. It is never wise to play the risk game instead of paying down your house but if you can act and function just like a bank and win the game in a guaranteed and predictable environment then nothing crashed down…and you win. That’s the key and it is possible.

Also, Dave, if you recall, most people had their homes insured but the insurance companies did not fully restore the homes. Come on, I know you remember those stories. So, all their money was in their house, it was destroyed, the insurance company didn’t restore the house as it was before the storm, and now they can’t get a loan on the house because they can’t get insurance on it because no insurance company is willing to take the risk again. It’s sad but you are mistaken if you lump this into a pool of only those that did not have insurance…that’s just not factual.

@Gman – that’s not right. Paying off your home actually gives more money to the banks. Your statement implies that the banks then collect less interest if you pay it off and therefore they ‘earn’ less money…i.e. “money away from the banks”. So, if the banks are in the business to collect interest and they earn less from you on a shorter term loan then please tell me why the banks offer you a lower rate on a 15 year loan than a 30 year loan.

If we follow your logic then this incentive would not make any sense. Why would they give me/you and incentive to pay less? It’s simple. Your money will never be worth more than it is today due to inflation. The more money they collect over a shorter period of time the more money they can spin back out and continue earning interest when it has its highest value.

The math proves, not me or my opinion, but math that banks earn FAR more money on shorter loan terms than longer loan terms for this very reason. That’s why they give you an incentive to do so.

As Dave Ramsey says, you don’t take fitness advice from fat people, so why would you take financial advice from (someone who has time to respond to a news article over and over again).

I doesn’t matter if the bank can turn the money around faster and loan it out to someone else and they offer lower rates because the money returned faster (therefore less at risk). More power to them, none of that is at the detriment of the person taking out the mortgage. Any financial calculator you plug the numbers in says that the faster you pay the principal balance the less interest is paid out and the less the total amount is paid to the bank compared to the total interest plus principal if they just made the regular mortgage payment. Period, end of discussion. Your advice is so bad as to be laughable.

She is smarter than you think, as she is leveraging the massive traffic this Dave Ramsey article is receiving on a daily post.

Bobby sorry but its true, regardless of whether you agree or disagree with Kelly.

You speak a lot like a banker, not a real estate investor… Correct me if I’m wrong but you said owning your own house free and clear is more risky (“riskiest”) then the bank owning your house? You’ve lost your mind.

I bet you he paid cash!!!!

http://www.fdave.com

Not if you’re the one in control of the money. Plus, think of emergencies, tragedy and opportunity. The one with the cash is king. Either the bank has the cash or you do.

Truly, if you say “I’ve lost my mind” then you’d have to believe that the model in which banks make money is ineffective. I’m confident you would not make that claim; therefore, you’re arguing in a circle.

That was funny. Still doesn’t mean I’m wrong. How many of you have read page 154 and 155 of Dave’s Financial Peace Revisited book? You should read it again. It illustrates his true lack of knowledge. I’ve even posted a blog on it at http://www.bethebank.wordpress.com.

Remember, Dave’s right-hand-man told me this; “kelly, you have to understand that 80% of our clients are financial idiots.”

risk risk risk kelly… to own a house or not… I think you have a screw loose.

Bobby, don’t leave comments under multiple names (Sam).

Editor

You must understand Bobby that banks make FAR more money off of your cash than they do your payments. Unfortunately you don’t have it quite right when you say their model is effective IF you borrow. They model is effective IF they have the cash far more than your borrowing.

Pretend we’re neighbors and we have identical homes. Your house is paid for and mine is mostly mortgaged and I have the cash to pay it off IF I wanted to and when I wanted to. We both lose our jobs. You may have six months of expenses but I’d have many years in cash. Let’s say a disaster happens like a tornado (I have a client in New Orleans who lost his home and one outside of Boulder Colorado who just lost his home this summer to a wildfire – but they had the money) and we lose our houses. Who’s in a better position? Not you. What if after the disaster no insurance company will insure your property once your old company replaced it (happened to my client in New Orleans)? Can you then get a loan on it again if you needed the money since you most likely burned through your emergency savings? Nope, no lender will put a mortgage on a house without insurance. Can you sell it to get the money? Nope, who would buy it if they couldn’t insure it? Again, my client in New Orleans saw virtually every neighbor go down the tubes financially because of this one financial decision…but not him – I got a GREAT Christmas card that year. But as for me, I’d have the money. Who’d be freaking out, me or the bank? The bank. Fine with me.

You see, when you do not have control of your money you are in the riskiest position possible…and you have NO control of equity. Cash is king. The math always wins here Bobby. It has nothing to do with my opinion. And yes, I can prove this with math. That’s the beauty of it. JD can call me a moron, you can say I have a screw loose…that’s fine but math is still on my side. Ironically, it turns out that if you saw the math and decided not to believe it then JD would be the moron and you’d be the one with the loose screw.

I do thank you for not behaving like a elementary kid on the playground by “calling names”…that only shows pure foolishness.

I really do not fall into the worship type adoration that many have adopted toward Dave Ramsey. I think his stuff is simple really and it helps many who have never learned to not put their life into credit BUT I don’t have as much respect for someone who pretty much plagiarized a much older book by John Avanzini and called it his own! He can pay cash for a house because he makes bank on other’s stupid choices and his system is such that many, many people never get pass step 3. I know so many DR fanatics who obsess over the steps – to the point that their new DR life becomes a bondage. They leave the bondage of debt to take on the bondage of DR and at the same time make him a multi- millionaire. I’ve always wondered if he would care so much about this nation’s debt and credit problems if he didn’t make millions from it?

Well, I guess Dave Ramsey likes his houses big, if nothing else. I am a bit surprised he is not following the (slowly) developing trend of smaller but better quality.

Let me hop in with some perspective from the standpoint of someone who has been a mortgage loan originator for twenty years and has owned a mortgage company for eleven of those years. First, “The Bank” rarely hangs on to the mortgage. They fund the loan using a special line of credit called a warehouse line. They then sell the loan for cash and a small profit to an investor. Fannie Mae and Freddie Mac are the largest and best known of these. Those mortgages are then pooled into a type of bond called a Mortgage Backed Security. The MBSs are bought and sold on Wall Street just like any other kind of bond. It is very, very rare that The Bank actually holds the loan in its portfolio. While it is true that one will pay less in interest by paying a loan of more quickly, it is important to keep in mind the opportunity cost of that money. Simply put, money will earn more money at some rate or return. If I invest cash into the equity of my house, the opportunity cost is the interest I forgo by making that investement. In the case of paying off a mortgage, we have to also consider the real cost of the mortgage. A mortgage with a note rate of, say, 4.75% may have a significantly lower rate by virtue of being able to deduct mortgage interest. Depending on my tax situation, my REAL rate might be in the mid-3% range or lower.

Here is a concept that Mr. Ramsey does not address, to the best of my knowledge: paying off debt is an investment–in fact, it is the only investment that is essentially riskless. So money being used to retire the principal balance is being invested at whatever the net cost of the mortgage might be.

If I have the ability to earn more on my cash than that rate, I will be ahead of the game by placing that discretionary money in some other investment that earns a higher net rate than the net cost of the mortgage. The difference between the two numbers is called the “arbitrage spread,” and it is how banks make their money.

If you listen to Dave Ramsey’s pitch, you’ll believe that a “quality mutual fund” will generate between 8%-12% per annum in net return. If I can borrow money at 3.5% and invest it at 8%, I am earning an arbitrage spread of 4.5%. If I do that, I will build net worth (wealth) far more rapidly than I would if I blindly followed Ramsey’s advice.

Does that make me a “slave to the lender?” Let me ask you this: I pay a couple of thousand dollars a month for my office lease. I am able to generate many times that amount each month in net profit for my business located in that space. Am I a “slave” to my landlord?

If I have a mortgage on my home, I am simply “renting” money for my benefit. The Bank does not own my home; I do. I possess the whole bundle of rights in that real property that I would have if I paid cash.

Dave Ramsey has become wealthy, not by following his own advice, but by creating a media enterprise to *dispense* advice–and as someone has observed earlier in this thread, the avid (and credulous) DR followers seem to accept all his advice as though it were Holy Writ. the problem is that much of his advice is based on incorrect assumptions, incorrect data or outright, um…falsehood.

Excellent post. The canned response by his followers, and Ramsey himself, is that you would never risk the money that is being used to create the arbitrage. Ironically, he claims that you will in fact earn 8-12% but somehow you won’t if your mortgage isn’t paid for…silly. Here’s the kicker, you can win the spread game without risk. You can win the spread game in a guaranteed and predictable environment. How could Dave tell me that creating spread in a risk-less environment is bad? He can’t because it’s not.