What Are My Best Mortgage Options?
These days you can’t listen to the radio, watch TV or open a newspaper without seeing an ad for today’s super low mortgage rates. Many of my clients have been asking “what kind of mortgage makes the most sense for me”?
People who are selling a home and then buying a new one are asking, “how much down payment should I be using”? Also, “should I pay all cash”?
Finally, the other question I am hearing is “should I be paying off my mortgage”?
Mortgage Options Quiz
I would like to take a few minutes to address these questions as the correct answers can save a homeowner hundreds of thousands over their lifetime. Let me be clear, I think folks should be paying off their mortgage as quickly as possible.
It is just that how you pay it off is what can make those hundreds of thousands of dollars difference over your lifetime.
Let’s start with a brief true or false quiz:
- A large down payment will save you more money over your lifetime than a small one.
- A 15-year mortgage will save you money over a 30-year term.
- Making extra principal payments will pay your house off faster and save money.
- The mortgage interest rate is the way to determine the true cost of your mortgage.
Everything You Own Is Financed
This is a very important rule of finance that many folks do not understand, to their own detriment. Every time you get a dollar, there are only 2 things you can do with them, save, or spend.
If you save, you earn interest.
If you spend, you forgo the opportunity to earn interest. This is called “lost opportunity cost”.
It is a very real cost and keeps many folks from ever building financial security for the long haul. Understanding this concept is the cornerstone of figuring out which mortgage is best.
Why Does Someone Get a Mortgage?
- You don’t have enough to pay cash for the house.
- You get a tax benefit (deduction)
- The chance to make an arbitrage as it costs less to borrow than you are earning on investments.
Today’s Dollars are Worth More Than Tomorrows’
Back in 1973, you could mail a first-class letter for 8 cents. Today it costs 55 cents. Same letter, same class, it just costs more. That means the dollars you are using today do not go as far.
This has been true for anything we are buying today; it takes more dollars to do the same thing as it did years ago.
The bank knows this and if they can get you to pay extra on your mortgage or take a shorter term, then they are paid back with dollars that are worth more and they get to use that to their advantage.
Another way to look at this is what is my payment worth at the end of my 15- or 30-year term? Well, if your payment is $2,000 today and inflation is 3%, in 24 years, that $2,000 payment is only worth $1,000 in today’s dollars! So, I ask you, does it make sense to pay the bank back with discounted dollars?
How Much Down Payment Makes Sense?
Each mortgage payment on a fully amortizing loan is part interest and part equity. When you put a down payment when getting a mortgage, is that money liquid? Does the principal earn interest?
In both cases the answer is a resounding NO!
Many folks say to me, “but my house went up in value”, however when you think about it, the home will go up or down in value, regardless of how big the mortgage is. And to get at your equity, you must deal with a gatekeeper.
In order to access equity you would need either a willing banker who has to say yes to a cash out refinancing, or a willing buyer to get at that value. If you need cash in a crisis, neither might be available to you, or the cost could be exorbitant (as it was in 2008).
For example, if you put down $100,000 on a $500,000 home and your investments are earning 5%, after 10 years, the home would need to be worth $62,000 more than you paid to break even. Double that for a $200,000 down payment.
For my home, in one of the strongest real estate markets in the country (Marin County), my rate of appreciation over the past 17 years is less than 3%! This is even though my home has doubled in value during that time.
I would be happy to show you what your rate of appreciation is, just contact the office and I have a calculator that will do that for you. The results can be very eye opening.
How Does That Help Me Pay Off The Mortgage Faster?
Well, if you look at the difference between a 15- and 30-year mortgage payment and invest that difference, the question is how much interest would I have to earn on that difference in order to pay off my 30-year mortgage in 15 years?
I looked online today to see what the lowest no cost loan interest rates were today. If your mortgage was $500,000 and you got a 15-year mortgage at 2.25%, the payment would be $3275 and a 30 year would have interest of 3.124% for a payment of $2140, that monthly difference would be $1135 per month.
In 15 years, the payoff for the 30-year mortgage would be $306,113. If I earned 5% on my money, I would have $304,637 in my account, which I could use to pay off the mortgage in 15 years, if that was in my best interest.
We can’t be sure that is the best thing to do, but you will have the option of paying off the mortgage or keeping the equity under your control, and that can reduce risk.
This is a very basic calculation and does not take in to account the lost opportunity cost on your principal payments or the tax deduction for your interest payment if you itemize. Adding those in would reduce the amount I would have to earn on my payment difference or allow me to pay off the mortgage sooner.
Mortgage Debt is Different Than Credit Card Debt
Consumer debt is when you borrow money for spending on things we consume. Things like clothes, cars and vacations. That type of borrowing will dramatically increase our cost of living and can become a massive barrier between you and financial security.
Mortgage debt, if properly managed, can accelerate your wealth building, provide liquidity and diversification of risk. After all, if the bank has given you a loan of 80% of the value, and your home burns down, they are on the hook for 80% of the loss and you could have money to start to rebuild if you had paid the mortgage off on your balance sheet.
Let’s Look at the Bottom Line
This has been intended to be a brief overview of some factors I hope you consider before you purchase a home or refinance. There are many more factors to consider that can’t be addressed in this format.
I am happy to have a discussion and provide the analysis to your specific situation so that you can judge for yourself.
Summing it up:
- Dollars today are worth more than dollars in the future, so keep as many as possible.
- Paying off your mortgage on your balance sheet gives you more control, more flexibility and more money.
- Using a shorter period mortgage or making extra mortgage payments will reduce your wealth.
- Taking advantage of today’s low rates can give you a strong opportunity to accelerate your wealth building through arbitrage and control.
There are great opportunities in the mortgage market today. Rates are historically low, and I would encourage you to take advantage of them. If you would like to compare mortgage options, call us and we can build an analysis of your options so you can make the most informed decision that fits your plans.
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.