How much connected are you with Bob Marley?
Robert Nesta Marley, OM (6 February 1945 – 11 May 1981) was a Jamaican singer-songwriter, musician and guitarist who achieved international fame and acclaim, blending mostly reggae, ska and rocksteady in his compositions. Starting out in 1963 with the group the Wailers, he forged a distinctive songwriting and vocal style that would later resonate with audiences worldwide. The Wailers would go on to release some of the earliest reggae records with producer Lee "Scratch" Perry.
Many people misunderstand or misrepresent the benefits of mortgages, and they get the key points wrong. If you read my book 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.
Misunderstand or misrepresent the benefits of mortgages
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.
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.
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 4% 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 $117,886. 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 $541,833 in 20 years! You’ll have nearly a quarter million dollars in new equity even if your principal balance never declines!
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.)
You get a 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.)
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.
Say you’re in the 33% tax bracket and you get a 5% mortgage. That loan costs you 3.35% after taxes, as shown in Figure 8-4. Meanwhile, say you invest money and earn 5%. Your profits are taxed at only 20%, meaning your after-tax profit is 4.00%. Thus, even if your investments earn no more than what you pay for your loan, you’re still making a profit!
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.
If you’re afraid that your home’s value might decline, 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.) 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.
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.
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 $300,000.
Should you use all your cash and make a $300,000 down payment? Or should you place only $60,000 down, which is 20% of the purchase price?
If you make the bigger down payment, your monthly mortgage would be $1,146, assuming a 4% 30-year mortgage.
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.
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.