Cash Flow And Principal Appreciation

How to live for free with real estate

The only reason why I open up my primary monthly mortgage statement is to check the split between principal and interest. My payment is fixed for three and a half more years at 2.625% so there’s never a change in absolute payment. It’s just fun to see the principal portion as a percentage of total payment go up over time. Progress is happiness.

The flip side to less interest payments is less deductions. I’ve calculated that mortgage interest payments are only truly worthwhile if you’re in the 28% tax bracket or higher. In other words, if your income is less than around $100,000 for singles or $200,000 for joint you’re not getting that much bang for your mortgage interest buck due to the standard deduction (~$11,900 for married couple, $5,950 for single) and the Alternative Minimum Tax. You’ll still be able to itemize and save on taxes, just not an optimal amount.

In this post I’d like to share with you how every potential homeowner or existing homeowner can live in their house for free using two main strategies that occur over the long run.


Goal: Lock in a mortgage rate equal to or less than the risk free rate.

It’s important to realize that if you take a fixed rate mortgage you are essentially SHORT bonds at that fixed price. If interest rates go up, you are winning because you’re locked in at a lower rate. Shorting a bond means you are making money on principal if the price goes down and interest rate goes up. Saving on monthly mortgage payments and increasing the value of your mortgage holding with the anticipated rate increase is the reason why I’ve been encouraging everybody to refinance their mortgage for the past three years.

If you still have difficulty grasping the concept of shorting bonds as a fixed rate mortgage holder, let me highlight my situation to help elucidate the point more clearly. I’m now living in a single family home in San Francisco for free because my CDs yield a blended return of 3.8% compared to my mortgage interest rate of 2.625%. The CD amount is roughly the same size as my primary home mortgage. With the median SF home price over $1 million dollars, this is a significant milestone.

To ensure that I continue to live for free in my home long after my CDs come due, I can invest an amount equal to my mortgage into a 10-year Treasury bond currently yielding 2.85%. The proceeds from the Treasury bond will pay for my mortgage and property taxes. I’ve been anticipating this day to come since the beginning of 2012 when I went through my 100 day refinance process. Dreaming of one day living in my house for free is what kept me from pushing on through the refinance pain!

Rising rates slow down house price appreciation in the short term because rates move on a daily basis and economics takes longer to adjust. But the reason why rates are rising is because of higher inflation expectations due to higher demand and tapering by the Fed. In other words, if you are a long term holder in property in a rising interest rate environment with a locked in mortgage you should feel BULLISH because your assets are inflating and the real value of your debt is declining. Only those who are trying to flip properties quickly panic.


Goal: Invest in a property whose annual appreciation grows faster than your cost of ownership.

We’ve now discussed the cash flow way of living in your house for free. Whether you want to invest only in a 2.85% yielding instrument is another story. Perhaps you’d like to invest in stocks with a strong belief you’ll make more than a total 2.85% return given the S&P 500 dividend yield itself is around 2% and all you need is 1% stock market appreciation. But the only things risk free are US government bonds, CDs, or cash.

Some of you might be thinking why not pay the mortgage off completely instead of arbitrage. You certainly can if you’ve got more liquidity behind and have a stable income flow. For most of us, it’s better to have liquidity just in case opportunities or disasters arise. The last thing you want is Hurricane Sandy destroying your home and the insurance company not making whole on their contract. What if your friend starts the next Twitter and asks you to invest? Keep your net worth diversified because strange things happen all the time.

Let’s now talk about the principal investment way to live in your house for free. Let’s say it costs $25,000 a year in mortgage interest, property taxes, and maintenance (4% annual cost to own on a $625,000 property). Your goal is to essentially make a call on the direction of the property market over the next 10 years. You can look on Zillow.com and punch in your the specific property, city or county for predictions. It’s important to understand the strength of the local job market, zoning laws, and existing housing supply to come up with the best guesstimate.

If your property can appreciate by more than 4% a year in this example, you will have essentially lived in the property for free if you decide to sell 10 years later. If you decide to hold on to the property for much longer by renting it out after 10 years, chances are high you will start making a nice cash flow return on your investment and see principal appreciation at the very least thanks to inflation.

Real estate versus stock market returns since 2001

RE outperforming since 2001, and roughly inline with the S&P 500 since 2011 at ~12% annual return

What can you say about the West Coast and East Coast dynamics in terms of price appreciation? Remember, as a housing economist you want to be unbiased and focus on demographic trends to make the best investment possible.

The markets don’t care that Chicago has some great deep dish pizza with an expected 1.5% depreciation in home prices. Areas are cheap for a reason! Perhaps the 760 shooting deaths in 2016 has something to do with Chicago not performing so well.


When you are able to gather at least a 20% downpayment to buy a property, please think about the two dynamics of comparing your mortgage interest rate to the risk free rate of return and the expected price housing price appreciation to your estimated cost of ownership in percentage terms.

I’m pretty confident if you regularly analyze these two dynamics you’ll be a much wealthier property owner in the long run. There’s no greater feeling than getting something for nothing after years of patience, due diligence or both. Don’t be one of the thousands of knuckleheads out there who got in way over their heads, defaulted on their mortgages, and caused pain for the rest of us. Spend as much time as possible before buying what could potentially be the biggest purchase of your life.

San Francisco Home Prices After Facebook IPO

Real estate owners in the SF Bay Area have been living for free and then some for a very long time.


Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.

Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns. Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.

Fundrise Due Diligence Funnel

Less than 5% of the real estate deals shown gets through the Fundrise funnel

Shop around for a mortgage: Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible from them or your existing bank. When banks compete, you win.

Updated for 2021 and beyond.

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