Banks Are Lying to You

The internet is an echo chamber of confusion and misinformation regarding finance. You can’t trust your bank, and your parents think the only measure of financial wisdom is taken in elbow grease. Given the difficulty of finding good financial guidance, I expect you will research my claims and verify the accuracy of my information. If you do that, and find I’ve shown you the truth, what will you do about it?

This information changed my life, and it can change yours too. I was recently talking with my good friend John, telling him how my personality changed when I learned banks had been lying to me. Maybe you’re familiar with the Meyers-Briggs assessment. When I learned a new way to use my money, I changed from a person who relied on perception to a person who relied on judgements, or in jargon, I changed from an INFP to an INFJ.

Disclaimer

Banks are great. I love my bank. And I’m going to be talking a lot of trash about banks as the title to this essay suggests. Just understand, we couldn’t do any of what we’ll review below without the banks, but until you accept that the front-facing services of the bank are stacked against you, you won’t be able to enjoy a fair and equitable relationship with you bank.

Learn some new rules, and you can prosper in a fruitful partnership with your local bank.

Financial Terms

Bear with me and make sure you’re firm on these terms. It may seem dry, at first, but I promise it’s rich and useful.

1. Amortized Interest: Amortization simply refers to the amount of principal and interest paid each month over the course of your loan term. It’s a prearranged calculation that has an inverse relationship with time. Amortization ensures that a bank is paid the majority of its interest before relinquishing the majority of your equity.

2. Simple Interest: Simple interest is best expressed as the equation Principle x Rate. A lot of information out there wants to add in term of loan to that equation, but that defies the most important element of simple interest.

3. Compound Interest: Compound interest can be boiled down most easily this way. It is simple interest in which the borrower must also pay interest on the interest accrued plus the principal.

4. Loan: A one-way sum of money lent to a borrower at an agreed upon repayment schedule.

5. Line of Credit: A two-way (more commonly referred to as “revolving”) sum of money available to a borrower that when lent must be repaid according to prearranged terms.

Food For Thought

Did you know the average homeowner moves or refinances every 6 years?

Did you know the average car owner buys a new car every three years?

The average term of a home loan from a bank is 23 years.

The average term of a car loan from a dealership is 5 years.

Life Changing, Personality Altering Information

If you’ve been asking why I’m sharing all these seemingly dry figures and facts, this is why. Go back to the first definition I provided if you need to, then ask yourself if you buy a home on a 23-year amortized note and sell it to move in six years, what was your interest rate expressed in simple interest?

Hopefully that question illuminated a light bulb over your head. If it didn’t, let me tell you this. If your bank offered you the same house but with 10% simple interest instead of 1.99% Amortized over 23 years, you’d save money and pay down the house faster at 10% simple. I encourage you to run the calculation for yourself.

Banks are smart. They’re full of sales people, marketing professionals, and number crunchers. And the sad truth is, most people are glad to let their banks “educate” them and tell them how money works.

Amortized interest has been such a successful marketing scheme in America for a few simple reasons. It allows banks to legally tell you they’re giving you a loan at incredibly low rates. You wouldn’t borrow if the banker told you the full truth.

Consider it this way. You go into the bank to get qualified for a loan, then you shop around and offer on a $200,000 house. The banker says, great, we’ll give you 1.99% amortized on a 30-year note, and you pop a bottle of champagne to celebrate because your loan is less than 2% and meanwhile your parents were paying something outrageous like 22%.

Meanwhile, the banker is sitting in his leather chair laughing sinisterly, as maniacal music plays in the background because he knows that both you and your parents are, in fact, paying closer to 70% expressed in simple interest.

And the banks will never have to admit to their schemes, well, not in language we’ll easily understand. The truth is somewhere in the fine print. And we all read the fine print…right?

Here’s how it works. The average homeowner accrues $2,500 of equity in their home during the first year of ownership: $3,000 in year two, $3,700 in year three, $4,200 in year four, $5,100 in year five, and $6,000 in year six. Then it’s time to move. Two things have typically happened in those six years: inflation and market appreciation.

Inflation and appreciation hide the banks’ dirty secret about amortization.

See, if inflation is 3% annually, and appreciation is a modest 7% annually a quick calculation tells you your house after six years went from $200,000 to about $350,000. You refinance or sell and pop another bottle of champagne because—hotdog!—you have $172,000 to spend on your new home. Don’t think too hard about the fact that the new home that would’ve cost you 200k will now cost you 350k so the appreciation and inflation are a moot point.

Last time you bought, you only brought $40,000 to the table. You’re feeling rich. The problem is, you feel so good, you don’t stop to ask how the bank feels. And let me tell you, if you did, if you asked, “Hey, Bank, how do you feel about my loan?” They’d say, “I feel great.” Cue sinister laughter.

The bank feels great because it effectively earned 70% interest on the money it lent you. Or think of it this way: for every dollar of equity you built, you paid the bank $1.45. Inflation and appreciation hid the fact that you actually only accrued $22,000 of principal over six years. During those same years the bank, by the way, accrued $31,900. That’s money you paid them, money you could have invested elsewhere for your retirement or whatever else you want to spend it on.

Well Thanks For Nothing, I Guess

Wrong! Hear me out. I’ve given you the bad news so you might receive the good news open-mindedly. What if I told you credit cards are our best friend? Don’t sic Dave Ramsey on me.

What if I told you it’s no big deal to ride a balance on your credit card and pay the 22% APR? That would take some explaining, I’m sure. But it’s simpler than you think. Would you rather pay 70% interest or 22% interest? Is that a good enough explanation?

Now you’re probably thinking, “Some good news, pal! I can’t buy a house with my credit card.”

You’d be right. But you can get a 1st position HELOC on your house, and then we’d be cooking with gas.

What’s a first position HELOC? Going way back to our definitions, it’s a Line Of Credit on your Home’s Equity: a Home Equity Line of Credit. It works just like a credit card, but it typically has much more favorable simple interest rates attached. A first position HELOC simply means the bank assumes your original loan, paying it off, and replacing it with a line of credit.

Most of the time, that line will give you access to around 90% or 95% of your equity. You’ll pay interest on any outstanding balance.

Keeping Things Simple

If you’re still reading, I’ve probably won you over, and now you need to know how this works. I’m not going to lie. It can be challenging. The first time I asked my bank about the mythical first position HELOC, I was told they didn’t offer it. A while later, I saw an investor on one of the real estate forums I’m part of mentioning the first position HELOC, so I asked him and he told me his was with the same bank I used and gave me a contact to talk with.

Banks are so much in favor of loans and amortized interest that they don’t even tell their own personnel about HELOC products that exist. You have to know the secret code and you have to be persistent, even threaten to take your business elsewhere.

National banks will probably let you leave because they’re bullies that way, but you’d rather bank locally anyway. So what are you waiting for? Go out and replace your loan with a line of credit!

The Mechanics of Financial Products

I wish banks would allow us to forego the loan all together, but so far, that isn’t the case. So to start with the first position HELOC, you’ll need to own a house with a traditional loan, and you typically need at least 20% equity in the home to make the transition.

If you’re in a position today where you don’t have 20% equity on your loan, you can plow extra principal payments into the loan to get there faster. In all other cases, you want to avoid extra principal payments on a loan, because that money becomes trapped and can’t use if needed, but when racing to get a HELOC, you know the money will be made available again when the bank replaces the mortgage.

A Few Words of Caution & A Case Study

Now that you’ve committed to the first position HELOC, I need to warn you of the only pitfall:

If you live above your means, i.e. if you spend more than you earn, lines of credit will destroy you. Unless you have a track record of spending much less than you earn, you’ll need to build a budget and stick to it. If you hate the B word, get over it or let the banks continue to dominate you.

Now, I will share with you, my own story as a case study. I bought my house on Lafayette Street back in 2015 for $95,000. At the time the loan was at roughly 4% on 30yr. fixed. I paid 20% upfront to avoid mortgage insurance (PMI).

After five years of living at that home, my wife, children and pet moved. We bought a house on Parker Street spent a few thousand to fix up the Lafayette property and rented it in June of last year, making it my first investment property.

Over the five years I lived at the house on Lafayette, we paid only the mortgage payments, except for one year we doubled up a single month because of our tax refund. When we moved, we had $32,000 in equity. $19,000 was our down-payment the remaining $13,000 was the added equity. Our monthly mortgage payment minus taxes and insurance was roughly $450, meaning the bank netted $14,000 over that period.

These are all modest numbers, but the illustration works regardless of the size of loan. The point is, and it’s clear, the bank won, and it’s happening to you too if you’re in the first half of your mortgage, more of your monthly payment goes to the bank than to your bank account.

By contrast, I now have a mortgage on my Parker Street property and a first position HELOC on my Lafayette property. In December of 2020 we bought another investment property. Before that, my HELOC was paid down to $20,000 remaining balance. To put that in perspective in six months, from June of ’20 to December of ’20, I plowed $40,000 into equity. Over that same period, the bank took $1200 in interest.

Stretch those numbers out and you’d see that if I’d had the HELOC for 5 years I’d have paid $12,000 to the bank in interest, saving $2,000 compared to the loan in interest, and most importantly, all things remaining the same, I’d have stocked away an astonishing $200,000 of equity.

This case study illustrates a few very important truths: You’re going to save a statistically significant amount of interest when paying simple interest, even at “higher” percentages, and the balance of who holds the equity is far more in your favor with a line of credit than it is with a loan.

I hope you are as astonished as I was when I discovered what banks were doing and how I could turn the tables. I hope you go out sooner than later and find a bank that will give you a first position HELOC. I hope you change the whole way you perceive borrowing and that your new viewpoint makes you wealthy with the banks instead of the banks becoming wealthier at your expense.