11 Great Reasons to Carry a Big, Long Mortgage
(For Informational Purposes Only - Please Seek Qualified & Trusted Professionals)
From The Truth About Money
Many people misunderstand or misrepresent the benefits of mortgages, and they get the key points wrong. If you read this chapter from The Truth About Money with an open mind, then by the time you finish, you will agree that you should have as big a mortgage as you can get and never pay it off.
Reason #1: Your mortgage doesn’t affect your home’s value.
You’re buying your home because you think it will rise in value over time. (Admit it: If you were certain it would fall in value, you wouldn’t buy it — you’d rent instead. In fact, your home’s value will rise and fall many times during the next 30 years — you just won’t get monthly statements showing you how it’s doing.) Yet, the eventual rise (or fall) in value will occur whether you have a mortgage or not. So go ahead and get a mortgage: Your house’s value will be unaffected.
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That’s why owning your home outright is like having money buried under a mattress. Since the house will grow (or fall) in value with or without a mortgage, any equity you currently have in the house is, essentially, earning no interest. You wouldn’t stuff ten grand under your mattress, so why stash $400,000 in the walls of the house? Having a long-term mortgage lets your equity grow while your home’s value grows.
Reason #2: A mortgage won’t stop you from building equity in the house.
Everyone wants to build equity. It’s the main financial reason for owning a house. You can use the equity to help pay for college, weddings, and even retirement. Mortgages are bad, many people say, because the bigger the mortgage, the lower your equity.
They’re wrong, and here’s why. Say you buy a house for $300,000, and you get a $250,000 30-year 7% mortgage. Your down payment ($50,000 in this example) is your starting equity, and you want that equity to grow, grow, grow.
Figure 8-3 shows what happens: By making your payments each month, your loan’s balance in 20 years will be just $143,250. You’ve added $106,750 in equity! This supports the contention that equity grows as you pay off the mortgage and that, therefore, the faster you pay off the mortgage, the faster your equity will grow.
But this thinking fails to acknowledge that this is not the only way you will build equity in your house. That’s because your house is almost certain to grow in value over the next 20 years. If that house rises in value at the rate of 3% per year, it will be worth $542,150 in 20 years! You’ll have nearly a quarter million dollars in new equity even if your principal balance never declines!
Reason #3: A mortgage is cheap money.
Mortgages, in fact, are the cheapest money you will ever be able to borrow. (Oh, sure, you can get a credit card that offers 0% interest for six months, but try to borrow a couple hundred thousand for 30 years that way.)
As Essential Mortgage Fact #1 showed you, you get the loan when you demonstrate you have the ability to repay it. But how much interest will you have to pay? The more confident the lender is that it will get its money back, the less interest it will charge you.
By offering your house as collateral, you agree to let the bank have your house if you don’t repay the loan. This dramatically reduces the bank’s risk, resulting in a very low interest rate. (By contrast, credit cards have no collateral; Visa can’t take the sweater you bought if you don’t pay the bill.
Credit card companies know that a certain portion of their cardholders will default, so they charge 18% to most cardholders. They figure that if a third of the cardholders default, they’ll still end up with a 12% return on their money. Not a bad business.)
Reasons #4 and #5: Your mortgage interest is tax-deductible. And mortgage interest is tax-favorable.
These two points are related, and together they offer you important benefits to carrying a mortgage.
Interest you pay on loans to acquire your residence (up to $1 million) is tax-deductible. The deduction is taken at your top tax bracket. Thus, if you’re in the 35% tax bracket, every dollar you pay in mortgage interest saves you 35 cents in federal income taxes. You save on state income taxes too.
And here’s the best part: When you earn profits from investments, those profits are taxed at 15% or less in 2010 — even if you are in the 35% tax bracket. Say you’re in the 25% tax bracket and you get a 7% mortgage. That loan costs you 5.25% after taxes, as shown in Figure 8-4. Meanwhile, say you invest money and earn 7%. Your profits are taxed at only 15%, meaning your after-tax profit is 5.95%. Thus, even if your investments earn no more than what you pay for your loan, you’re still making a profit!
Reason #6: Mortgage payments get easier over time.
Carrying a mortgage actually gets to be fun. Yes, fun. My father used to love to talk about his mortgage — all $98 per month of it. You see, he and my mom bought their home in 1959 for the whopping price of $19,500! Yet, my dad used to tell how his father thought he was crazy.
How in the world was my father going to be able to handle such a huge mortgage payment, Grandpop Max asked. After all, my father was earning less than $3,000 a year back then. To spend $1,200 a year on mortgage payments ... Grandpop Max thought my dad was nuts!
Of course, by the 1970s, Dad was laughing about it. Why? Because his monthly payment in 1974 was identical to what he was paying back in 1959. Yet, Dad’s income had risen steadily. Thus, his mortgage payment had become insignificant when compared to his income — not to mention the fact that his house had grown substantially in value.
You probably remember struggling to make your mortgage payment when it was new. But over time, that payment becomes cheaper relative to your income — especially if yours is a fixed-rate loan: Payments on such loans will never rise but incomes usually do.
Reason #7: Mortgages allow you to sell without selling.
Have you noticed that your home is worth much more than it was 10 years ago?
You might be worried that your home’s value will fall — after all, in many parts of the country, the real estate market is not as strong as it was earlier this decade.
If you’re afraid that your home’s value might fall, you should sell the house before that happens. But you don’t want to do that! It’s your home, after all. You have roots in the community. Uproot the kids? And where would you move? No, selling is not a practical idea.
Still, you fret that your home’s equity is at risk. Can you protect it without having to sell?
Yes! Simply get a new mortgage, and pull the equity out of the house. It’s the same thing as selling, except that you don’t have to sell!
Here’s how the idea works: Say you bought a house for $200,000 with no money down (meaning you owe the bank $200,000). Further say that prices have skyrocketed, and houses in your neighborhood have been selling for $500,000. You fear that prices will fall, dropping your home’s value to $400,000.
If you sell now for $500,000, (Assuming that you can, and ignoring real estate commissions and other selling expenses, and pretending that you still owe the bank the full amount of the original $200,000 loan. Work with me here people.) you’d pocket $300,000. But you don’t want to sell, so just refinance and get a new loan for $500,000.
You now have the $300,000 in hand — just as if you had sold the house! Obviously, this is an extreme example simply to prove a point: (I’m not necessarily suggesting you actually get a new mortgage that’s two-and-a-half times bigger than your old one - although I might, depending on the situation. And don’t forget the tax limitations regarding the deductibility of the large new loan.)
Borrow the money now, because you won’t be able to do so after the house falls in value. (For example, if you plan to use the equity in your house to put the kids through college — not that I’m endorsing that idea — you should get the loan now so you don’t have to worry that the house might fall in value later.)
I’m not suggesting that you’d want to owe more on the house than the house is worth. But that’s certainly better than watching the equity evaporate before you have a chance to use it.
Get the equity out of the house now, while you can — a lesson many people wish they’d acted on back in the 2000s.
Reasons #8 and #9: Mortgages allow you to invest more money and to invest it more quickly. Mortgages allow you to create more wealth than you otherwise would.
As I mentioned in Reason #6, people get big mortgages on their first home simply because they don’t have a choice. You’re excited about buying a house, and even though you don’t have much money, you have a good income — two good incomes, if you’re like many couples. Some years later, with a growing family, higher incomes, and newfound equity in the house, you’re ready to move up to a bigger home.
Let’s say you net $300,000 from the sale of your old house, and you’re ready to buy a new home for $500,000.
Should you use all your cash and make a $300,000 down payment? Or should you place only $50,000 down, which is 10% of the purchase price?
If you make the bigger down payment, your monthly mortgage would be $1,331, assuming a 7% 30-year mortgage. If you make the smaller down payment, your payment will be $2,994 per month.
This explains why so many people prefer to make big down payments when they buy houses. A big down payment translates to a small monthly payment. In our example, that big down payment saves you $1,663 per month.
But the people who are trying to ask you to choose between big monthly payments and small monthly payments are lying to you. Yep, they’re tricking you by asking you the wrong question.
The correct question is not about the amount of money you want to pay monthly, but the amount you want to invest. Again, it’s all about wealth creation, not debt elimination.
Here’s the question you should be answering:
Would you rather invest:
$250,000 right now, as a one-time-only deposit
$1,663 a month, every month, for the next 30 years?
Obviously, you’d prefer the strategy that results in a higher profit. And Figure 8-5 reveals the answer. Regardless of the time period, investing a large amount now produces better results than investing small amounts over long periods.
Thus, while a low mortgage payment lowers your overall expenses, it also lowers your overall wealth.
But you suspect there’s a flaw here. In order to invest that $250,000, you’d have to be willing to accept the higher monthly payment. Where will you get the money to do that each month?
You’ll find the money from two places. First, increase your paycheck! Remember that the new loan payments are almost entirely tax-deductible interest. That means you don’t need to have as much money withheld from your paycheck. So file a new IRS Form W-4 at work to increase your exemptions; this will reduce the amount of taxes that are withheld from your paycheck, boosting your net pay. Yes — you’ve just given yourself a raise! And you can use this increased paycheck to help you pay for your new mortgage payment.
Second, if your paycheck isn’t enough, simply make periodic withdrawals from the investment account you’ve just created. Soon enough, as your income rises, you won’t need this crutch; your income will become enough to handle the cost, as shown in Reason #6.
In fact, getting a big mortgage and using investment proceeds to help you make the payment is superior to getting a small mortgage and having no proceeds to invest. This is especially true when you discover the most important reason of all to carry a big, long mortgage...
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