Is a mortgage really a good idea?

Factual Questions
41

So did I, but another one.

My argument against such reasoning is that in a mortgage you are not losing money in the manner of compound interest. It’s not like debt on a credit card, where if you don’t pay up in full, the leftover balance increases by a rate of, say, 16% per annum. A mortgage loan’s interest rate does determine the size of your monthly payment, but once that’s settled and everyone has signed on the dotted line, the P & I portion of your payments is fixed. (Assuming a fixed-rate mortgage that is.)

True, nada or near-nada is a possibility. However, the stock market is generally a good investment over the same time scales as a house mortgage: i.e. 15 to 30 years. There are no guarantees of course, but historically the market has a long-term average rate of return of around 8 to 10% I think — which beats mortgages currently on offer.

42

That’s interesting.
Did this financial planner explain why you shouldn’t just get a MODERATE-sized house, never pay it off, and use the money left over to make even more investments?
Her whole plan sounds cock-eyed, both for that reason, and the reason you cite.

43

Ramsey seems to be neglecting the effects of inflation also:

If your paying rent, your rent will keep increasing apace with inflation.

Inflation will be eating away at your savings, or at least moderating the returns. You deposit todaydollars, and withdraw inflation shrunk futuredollars.

You can effectivly subtract inflation rate from your mortgage interest rate. You buy with todaydollars, and repay with inflation shrunk futuredollars.

Inflation just adds to normal real estate appreciation.
So by my reconing the saver has the following working against him:

-Taxes…double wammy as most investment earnings are taxed as income, while the spender gets a tax break on his interest payments.

-Inflation

-Appreciation

-Rent

-“Mansionizing”…average house keeps growing in sq. footage and price.

-Sprawl…affordable housing keeps getting farther and farther from likely employment .

-Generally declining construction standards: Cheaper and cheaper materials being used. While these may be adequate, durability is unproven, and repairs/remodeling may be complicated. (easy to patch a wood stud, not so easy with metal studs.)

-Expectations/needs: The saver may well have a family by the time he is ready to buy. The spender just sells his old little house at a profit and upgrades.
Anyway, The only people I know of who got hurt buying early in life bought a really shitty house at the interest peak of the late 80’s and only stayed in it for a couple of years…and they still only got a mild sunburn, not a 3rd degree scalding.

OTOH, everyone I know who is living paycheck-paycheck, if not outright drowning in debt is a long term renter.

44

I don’t understand such things at all well, but it seems to me that the statement is incomplete. A mortgage is leverage. You are buying on margin. If the house price increaes Mr. Ramsey is likely to be wrong. If house prices fall then Mr. Ramsey is at least right enough to have protected you from the negative leverage. In most cases-I believe he is wrong even assuming that somehow a renter could actually save up enough to buy a house outright.

45

Well, yes, the advice was to do exactly that. Not to buy the biggest house, but to get the largest *percent * of it financed as possible, and to never pay it off. Sorry if I was not clear.

46

Which in this context is stoopid because you have to live somewhere, and if you don’t have enough to own a house outright, you’re going to be paying rent or mortgage repayments.

47

Dave Ramsey is an idiot apparently with no knowledge of basic finance.
I think MLS’s finance advisor is basically working off the premise that money now is worth more than money later (NPV). The idea is that you make the lowest monthly payment you can and invest the cash. Theoretically, your payments should be less and less a % of your income.

48

Dave Ramsey is an idiot apparently with no knowledge of basic finance. As already been pointed out, most people can’t afford to save that much AND pay rent. Anyhow, they’re pretty simple calculations to figure out which method has a better payoff.
I think MLS’s finance advisor is basically working off the premise that money now is worth more than money later (NPV). The idea is that you make the lowest monthly payment you can and invest the cash. Theoretically, your payments should be less and less a % of your income.

49

Real estate investing is so simple I can explain it in a few sentences.

You have a property. You have a price. You have an NOI (net operating income–the money the property produces before you figure in interest and taxes). NOI/price is essentially the ROA (return on asset(s)) or in RE parlance, the “cap rate.” If a property is producing income, the bank will loan you money to buy it with the property itself as collateral. You pocket the percentage difference between the loan percent and the cap rate, deduct for interest expense, pay taxes on that amount, and voila, you’ve made money. The fact that you used the bank’s money instead of your own to buy the property is called “leverage.” This is how most RE deals work.

The same principle applies to buying a home. As everyone knows, you are allowed to deduct the home loan interest from your personal taxes, much in the same way that a business can deduct interest expense. Now imagine you had a home that was free and clear worth $100k. A home loan will run you 6% interest. If you mortgage your house and get $100k, you can then invest that money. If you can earn a return of more than 6%, then you are profiting. But the government further sweetens the deal by making that interest, in this case $6,000 for the first year, deductible. If your tax rate were 33%, then you would save $2,000 on taxes, so it is really as though you were paying 4% in interest. If you can get a return of over 4%, you are in the black. (There is no way the above numbers are going to be that simple, but this illustrates the idea: the deductibility of the interest effectively lowers the return you need to make the transaction profitable for you).

If you can earn a capital gain on your home, so much the better. The government also sweetens that deal in a major way by making up to $500k free of capital gains tax (for a married couple, $250k for a single person) if you live in the home for 2 of 5 years or something like that (check with people who know all this cold before investing!). So you can make a mint on your house and not pay a dime in tax!

What takes away the sweetness of the above deal is additional costs such as maintenance, taxes, and insurance (noted by previous poster). BUT, you have to live somewhere, and it still usually beats renting (freedom, etc., noted by previous poster).

The above, ceteris paribus, will generally make owning a home preferable to renting. But there are plenty of potential and, in certain US markets, actual exceptions. We looked at houses in Tokyo where houses are considered fully depreciated and trashable in 30 years (i.e., you never get a capital gain on the building) and where average land prices are 50% OF what they were 10 years ago. You are almost certain to take a capital loss on anything you buy. In such a market you buy for QoL and usually intend to settle down for good in that house.

In certain US markets, the market is such that it is cheaper to rent the asset than to buy it. When you consider in, out, risk, mobility, and total lifetime value of the transaction. I can’t imagine it being a good idea to buy a condo in Manhattan as opposed to renting a similar space, but I would like to see the numbers.

50

Another thing to consider is that although you can deduct the mortgage interest, you also have to report gains on other investments. Thus, it is more correct to state “If you can get a return of over 4% after taxes…”.

I don’t know this Dave Ramsey person, but I happen to be one of those rare people who doesn’t have a mortgage… it works for me. I tended to be rather nomadic, so there is quite a bit of savings associated with not paying realtor fees, property tax, and closing costs. I rented until I could afford to buy outright.

I wouldn’t make a big decision like purchasing a home without crunching through all the numbers. If you factor in property tax, closing costs, HOA dues, and every fee, you’d be surprised at how much it costs to buy, keep, and sell a property.

Also, if someone plans to live at the same place for 15 or 30 years, but circumstances change and they find themselves needing to move in a couple of years… it can be shocking how many thousands of dollars they’ll be out.

51

Sure it’s a good idea. It’s just that at a minimum of $400,000 for a studio, most people can’t.

Also, there is the fact that many if not most appartments in Manhattan are “co-ops”. Basically you need to get the approval of a board to buy in the building, you have to follow their rules while you live there and you need their approval on who you sell it to. To a certain extent, that adds additional barriers and disincentives to buy in Manhattan.

52

Others have answered the question about what it would do to the length of the loan.

On the tax standpoint: The only impact is that because you’re paying off the principal faster, you’re paying less in interest each year. Let’s say your extra principal causes the interest amount in year X to drop from 10,000 to 9,000. Then your itemized deduction for that year goes down 1,000. Which causes your income tax to rise by, say, 280 bucks (if you’re in a 28% tax bracket). Obviously you’re stil saving that 1000 in cost, but your net savings is only 720.

Taxes upon sale of the house wouldn’t affected - they’re based on the difference between the purchase price and the sales price, regardless of how much you may owe on the mortgage. So if you have a house that cost 100,000, and you sell it for 500,000, your profit is 400K regardless of whether you owe 0K, 500K, or any amount in between. The extra payments would just reduce the outstanding mortgage so you’d get to pocket more of that 500K.

Some advisers these days are saying you should expect to always carry a mortgage, that the extra money is better used for investments. I don’t buy that (and apparently Dave Ramsey does too).

53

When the idea of investing on borrowed money comes up, Ramsey seems inclined to bring up the value of “risk avoidance” and the fact that people who use borrowed money to bet on investments should factor in the “risk factor cost” [not his exact words] of the investment.
I am not mathematically or financially astute enough to evaluate the arguments he makes at that point, and he doesn’t spell out his math.
As a hijack, does anyone here have a web site that might explain to me, in terms that someone who never went past MATH 1100 in college could understand, how to evaluate and assign values to the risk associated with investments?

54

Mama Zappa gave you the safer answer that my banker friends tell me. However, I like to gamble on just about anything and this reply will allude more to the “always holding a mortgage” idealogy (a growing minority).

Long story short and very simple (and since I’m not a finance attorney), it’s been explained to me that this approach (paying good debt slower) can be successful if you’re disciplined with the cash you save and invest wisely, and be willing to take a moderate risk. The basics are that with interest rates so low, and with inflation rising, the money you borrow is basically free. Ex: 30 year mortgage, 5.1 (might’ve been 5.2)% interest (quoted to me last week), assuming a 3% interest rate (generous rounding), basically you have to beat a 2% return on your investment (ROI).

Take the increase in salary, subtract taxes, and invest in something that is known to beat 2%. In my case, I like to gamble, so I’ll invest in the stock market, which has a 15 (or is it 30?) year return rate of 12% (I’m not sure of the actual rate, I think Motley Fool said it was 15%). Something safer might be invest in CDs and keep rolling it over (less interest, but more liquidity, but more taxes, but more stability). In raw numbers, you have to beat the money and time you would’ve saved had you paid off your house early (or one extra mortgage payment per year).

To me, that’s a good gamble. My numbers (and possibly math) isn’t as solid as Mama Zappa’s, but hopefully you get the idea. If anyone wants to poke holes at this theory, by all means go ahead. I plan on implementing this next year when I finally buy my house.

55

Given that you have to live somewhere, the cost of keeping a roof over your head might as well go toward equity for you instead of equity for a landlord.

The only way I can see Ramsey’s position making any sense is if you’re willing to live in really cheap digs while saving toward a place of your own (thus being able to afford somewhat better digs once you do take the plunge). Even then, I don’t see a good reason to put more than the traditional 20% down.