How is it possible to "profit" from real-estate when so much of the mortgage is used to pay off interest?

Bay Area
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This was interesting question and answer in reddit. Just sharing with forum members

Question:
Newbie question: Can someone please help me understand how you can profit when selling a home?
I understand that when you buy a home the majority of your mortgage payments, in the beginning, go to pay off interest first. So how does one make a profit from real estate (assuming the house goes up in value) when they sell a property? Isn’t the profit just going to cover the cost of the interest payments thereby nullifying any “gains?” Unless the value has gone up significantly, wouldnt a seller just be breaking even?
TL;DR - What’s your approach to making profit in real-estate when you’ve got interest payments getting in the way?

Answer:

Either from gains in value of the property, or/and by collecting rents.

Say, you buy a $500k property with $100k down. At an APR of 3.7% you pay roughly $1,825 per month in interest in principal, you have a remaining balance of $311,903 after 10 years. You paid a total of $132,839 in interest. Say the property has increased in value to $600,000 and you decide to sell it. Taking into account the remaining balance on the mortgage ($311,903), you have grown your initial down payment of $100,000 to $288,097. However, you have incurred the cost of interest, which we subtract from the $288,097. Which comes down to ($288,097-$132,839 =) $155,258.
To calculate your return: ROI = (gain from investment - cost of investment) / cost of investment. Return = $155,258 - $100,000 / $100,000. Return = 55.26%. Not too impressive, given that you took 10 years to get this return (annualized 4.5%)

In same fashion, you can rent it out and have someone else pay the mortgage on your property. Double win there: potential for increased value of the property, as well as slowly getting the ownership of the property in question.

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Also, you need somewhere to live. At least part of the mortgage goes to principal. 0% of rent goes to building equity. Plus, there are the tax deductions for owning. You also have relatively fixed costs vs rent increasing with inflation. If rent vs buying is close in monthly costs, then owning is better.

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They should teach this kind of basic personal finance stuff in high school. Forget Shakespeare. Learn some basic mortgage math. :slight_smile:

Forum members should volunteer to teach some RE kungfu in local schools.

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This is all available in high school math, but students run away from such math until they go to job and looking at the pay check !

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Maybe they teach the abstract math part. But the practical importance of owning their personal finance is not taught or at least not learned. Otherwise how do you explain the lure of Bernie?

I just started playing monopoly with my older girl. So far she loves it, and often stops to count how many dollar bills she has. Am I creating a monster? :smile:

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Most of the members here are very calculative, will not be lured by Bernie etc ! I feel it is inherent nature by the individuals, not specifically taught from schools. Of course, basic math from schools.

Specific to investments, Schools have optional projects, but community colleges has got courses.

For example:My son took stock investment ,in Lynbrook, as one of his 7th (or 8th) grade project. IIRC, There were set of students (appx 10) took similar one as a part of management course.

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Teaching investment is like teaching a kid how to run before teaching how to walk.

First rule: Do not borrow money for consumption. No ifs or buts.

Edit: Sorry, a better analogy is: learn to stop the container from leaking first before learning how to fill the container. This analogy is better in that it encompasses two principles: Live within your means, and don’t borrow money for consumption.

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I find the reddit approach not very logical, IMHO (ignoring time value of money and other costs for simplicity):

Cost of investment = Initial downpayment + 10 years worth of monthly mortgage payment.

Gain in investment = Sale price less purchase price + imputed rental less mortgage interest.

Just to get a feel, if imputed rental = $1825/ month, return = 58% :grin:

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The reason the middle class is falling behind is they use debt to finance consumption. Then too much of their income goes to interest payments on depreciating assets. That won’t help accumulate money. You can see the decline of savings rate vs prior decades. The savings rate was lowest before the real estate collapse. People thought it was a great idea to cash out home equity to buy cars, TVs, vacations, furniture, etc.

It’s horribly unsexy to live below your means and save. People aren’t complimenting someone when they call them cheap.

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You hit the target !

It is their ignorance. I had the same ignorance of not knowing the power of Roth IRA when I was eligible ! Saved money in taxable account instead of contributing Roth !

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For me, this was the most influential guiding light if you will:

“You don’t want to just work for money. You want to get to the point that your money is working for you.”

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Trump proved it right ! Money works for him…

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I have a better plan, you may want to hear me out.

How about if you recapture 75% of your home, car, you name the expenses every month? You need to have some $ cushion, or maybe not, all depends on the details of your health condition. Take a look at this insurance policy. I recently did my research and found it with another group within my company:

Monthly expenses total $5K. It could be you the investor, or anybody, a renter, a business man, anybody.

You open a life insurance policy for $5 monthly premium, it could be $1K, up to $100K +
First month your premium is $5K
Second month you pay the second premium. Immediately you loan $3,750 (never paid back, tax free)
Third and subsequent months you do the same, $5K in, $3750 out. You can also leave the money in the policy for better future use and pull it out whenever, 75%!

At the end of the year you have paid a premium of $60K and loaned what? $45K? (I know, the first month is lost, right? But that depends on your health and if you don’t pay 3 months premium).

OK....how much you have left in your policy? $15K? Right?
 Answer? Wrong! Still what you paid in premiums less the cost of insurance. Let's put it so bad, things don't go that good with the economy, you have left $45K in your account earning from 0 (2008) to 8% compound interests. Your principal is never touched for investment purposes, the indexing concept is applied.

Tell me, what could have happened to that money if you pulled it out of your bank account? You would have how much $ left? 

 Answer: Zero!

For those in the age of retirement, those who don't want to hear or be next to an investment property, and those who can't escape the 1031 exchange dagger, I know of good plans so they avoid that and capital gains, and not paying taxes for 6 years to offset some expenses. Their property is off the grid, it disappears from your estate. Income for life and the life of your kids.  :innocent:

You pay $60K or more in taxes as an investor or as a self employed individual? I can show you how to pocket/deduct 75% for your retirement. :sweat_smile:

By the way, I did some illustrations for some guys here in the past, my bad, I have better deals now. :innocent: