Confessions of an ARMs Dealer

by Brian Brady

Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL

Author website

Strategic Equity Positioning is a buzz phrase in the mortgage industry today. The concept of equity management came from the book, Missed Fortune, by Doug Andrews. Andrews, a life insurance agent and financial planner, discovered a strategy that extracts equity from your home to fund tax deferred investments. The response was nothing short of remarkable. A study by the Chicago Federal Reserve Bank remarked:

“..taxpayers with incomes over $100,000 a year who use mortgage-deductible interest as part of an arbitrage strategy in retirement accounts would appear to have the most to gain, and the authors find it “puzzling” that more people who are in “better financial shape” than the average taxpayer don’t take advantage of this kind of strategy.”

I first heard of the term “equity management” in 2003. I heard Barry Habib discuss this concept at a seminar at the Del Mar Racetrack (critics, please refrain from pointing out the obvious irony). My first thought was “Cool, they have a name for it now!” You see, I am an ARMs dealer and have been since 1996. My background was on Wall Street as a financial consultant for two major wirehouses. I learned about financial planning in Plainsboro, NJ.

I met a man from Wachovia Bank (nee World Savings), Mike Cushing, in 1996. Mike taught me how to properly analyze negative amortization loans. He taught me how to temper the negative amortization with bi-weekly payments. I seized the opportunity and developed the mantra “Go Negative and Invest the Difference“. This mantra was not unlike the one espoused by Art Williams as he built the insurance empire that eventually became Primerica (now owned by CitiGroup). Art Williams encouraged Americans to “Buy Term and Invest the Difference“.

When presented with the idea of extracting equity to fund investments, I was puzzled. It seemed, well…kind of reckless. I was taught that the NASD forbid recommendations that would extract equity to invest when I attempted this arbitrage play for a securities client in 1990. I’ve since learned that the NASD softened their stance in 2002 with a strict admonition that the loan and subsequent investment pass a suitability test.

Let me illustrate this concept with a simple case study. I helped a financial planner and Realtor advise a 52 year old physician in San Diego who was woefully underprepared for retirement. He owned a home in San Diego, CA worth $900,000 and an investment property in the Bay Area worth $500,000. He wanted to buy a home in La Jolla, CA for $1.5 million. He was sitting on about $1.2 million in equity. He is in his peak earning years so we wanted to employ a strategy that allowed him to minimize taxes while saving for retirement.

The physician’s “plan” was to sell the San Diego home and investment property and carry a $300,000 mortgage on the La Jolla home. He felt he could pay it down in 12 years and comfortably retire by supplementing his income employed as an attending physician.

We suggested a $400,000 loan against his investment property with a 10 year, interest-only payment. The rent and depreciation covered his costs and the transaction netted him $300,000 in cash.

We suggested that he sell the San Diego property (netting $700,000) and purchase his dream home in La Jolla. We funded a $1,000,000 loan, interest-only for ten years, so that he could maximize the tax benefit of the home interest deduction. He was left with some $500,000 for investment into a tax-deferred, variable annuity.

Our “sweet spot’ for him was to grow that annuity to at least $1,400,000 within 12 years so that he COULD pay off the loans if he chose to do so. Rather than paying down the mortgage, we encouraged him to systematically invest in the the deferred annuity (remember, he planned to pay down $300,000 over ten years).

We thought that tax-deferred annuity can return 7-8%; last year it returned 12%. We thought that his investment property will be worth $750,000 in 12 years. Here’s the best part. We successfully sheltered some $93,000 in income through this strategy; that saves a high earning Californian some $25,000 in taxes (he may be subject to AMT or the savings would be closer to $40,000). That $25,000 just funded his systematic investment in the deferred annuity.

CONCLUSION: This works. It”s a simple arbitrage strategy and the wealthy have been employing it for decades. The annuity is a tax advantaged vehicle and the mortgage is a tax advantaged vehicle. It can work for investment real estate, also. Americans have to learn to love their mortgage rather than hate it. Proper planning and professional advice can teach Americans how ARMS are actually a much better solution than fixed rate loans.