11 Great Reasons to Carry a Big, Long Mortgage

[SimpleLife]

I must admit, with one house paid off and another one I'm about to pay off this summer, this guy makes some compelling reasons to not only keep the mortgage, but buy a bigger house. I also liked his idea about getting equity out of a house that's appreciated and using it to invest. Not saying I would do it, but for wealth building without being a landlord, buying the 500K house that appreciates at 15% a year on a 500K house builds a lot of equity fast and allows you to deduct 10K+/- a year in interest in the early years (unless you keep refinancing) if you are in a high tax bracket. Plus your income will go up as inflation adjustments are made while your mortgage is fixed (except for insurance and taxes!). Not saying I would retire IN said McMansion, but one could downsize after using it to build wealth. Some compelling arguments in the article.

http://www.ricedelman.com/cs/education/ ... 20Mortgage

[jacob]

15% unleveraged is extremely good... but in general the housing market appreciates no faster than inflation in the long run. The Feds did a study.

[robby152]

In general, any real estate investing strategy makes sense if you count on appreciation over inflation. Unfortunately, that doesn't happen often, and when it does it is usually in select locations for an unpredictable amount of time. That line of logic has been around since the 80s and has burned a lot of people, though made some really wealthy.

[IlliniDave]

In general, any real estate investing strategy makes sense if you count on appreciation over inflation. Unfortunately, that doesn't happen often, and when it does it is usually in select locations for an unpredictable amount of time. That line of logic has been around since the 80s and has burned a lot of people, though made some really wealthy.

It made Dave Ramsey really wealthy! Playing the leveraged real estate game is how he went broke/bankrupt, and recovering from that lead to the start of his present business.

[Tyler9000]

I remember when I first moved to the Bay Area in 2007, one person told me I'd be crazy not to buy a house on an ARM because "houses always appreciate 10% every year". Two years later, the housing crash drove them to bankruptcy. Volatility is important.

I also find the mortgage interest deduction a shaky argument. I just finished my taxes, and the standard deduction beats itemized easily with my reasonably priced home, making the mortgage interest deduction irrelevant. Is deducting a little more in income taxes really worth getting an insanely expensive home? Basically, I find a lot of articles like this promote unnecessary consumption.

[Scott 2]

So a wealth management comany (that gets paid a percentage of assets invested) encourages borrowing to invest. Nice conflict of interest there.

Buying more house than one needs, for the sake of accumulating wealth, is a mistake IMO. The carrying costs are too high and the value too unpredictable. If one falls prey to lifestyle inflation from the influence of wealth neighbors, the sky's the limit.

IMO for the individual investor, there is rarely a certain answer as to whether or not carrying a mortgage is smart. A lot of it depends on how the other investment options that are available are doing. In 2009, yeah paying down the house instead of investing was probably not the best option, allthough I did a little bit of that to support a refinance. In today's market, I think paying down the mortgage is a very reasonable choice.

Currently I am maxing out my tax advantaged investment accounts, then paying down the house. In a few years, I'll be done, then put that money towards other investments. Long term, since I'm living well below my means, the house will be a relatively small percentage of my portfolio. Whether or not I carried a 30 year mortgage probably won't matter much.

I do know I will derive irrational satisfaction from no longer having a mortgage. Every time I hear about someone else's house payment, I will get a hit of pride at how awesome I am. It might not be logical, but knowing it will make me feel good, makes the decision easy.

[dot_com_vet]

I've found maintenance costs wipe appreciation clean.

There's a reason the largest houses eventually become "white elephants".

[SimpleLife]

Yeah, the maintenance can be a bear on such an expensive house, and over decades, it is true that most houses would appreciate barely at the place of inflation with exception to places like SF for example, heck, a few months ago I read that noted that houses in most of the country have actually not kept up with inflation until more recently, and that for a long period several decades ago, they didn't keep up with inflation much at all.

But for me and perhaps others who live in hot markets and would use it as a short term investing strategy to build assets WITHOUT using 100% of their own money, at the right time, it could be worth it to build up assets rapidly in this way using leverage rather than 100% of your own money currently tied up in dividend stocks or an index fund. That's the key advantage to this the way I see it. It would only be worth it if you bought near the bottom and got out after making a huge profit near the top before the bubble burst, no more than 3 to 5 years of holding onto it. I wouldn't hold it forever.

I'm currently doing that with real estate I bought near the bottom but on a slightly smaller, spread out scale (both of my houses together total close to 500K). I have one more year before I have to sell to avoid capital gains tax on my rental and it'll still be 15% below it's 2007 peak, but I've made a mint off it. Like I said, I got in at the bottom, got it while the getting was good, and am planning to get out before I owe taxes for capital gains, a new roof is needed, etc.

In the article, the concept is the same just on a larger scale; if you can make 75K in appreciation a YEAR for three years on a mcmansion , then sell it before the bottom falls out, that's quite the boost in assets. I don't necessarily agree with his "hold onto it forever" logic for my personal goals although there are some merits for other peoples situations in that line of logic. For me it would only be good for a short period of time while the market is hot WITHOUT having all of your cash tied up in a paid off house.

You can buy a house with the minimum dp, while you leave your cash in an index fund as usual, as you live in the house for a few years and let it fatten, then refi and use the money to pay cash for a more reasonable house and sell the mansion. You basically used leverage to increase your assets substantially, used the gains to pay cash for a more reasonable sized house, all while letting your cash in index funds fatten up as well.

Even if you are strapped for cash to buy a new place while sitting on this one, I find it a rather simple strategy (much like the one caterpiallar recently used to avoid billions in taxes simply by changing the name of one of it's subsidiaries) to refinance in an effort to tap the appreciated equity which you can then use to pay cash for a smaller, more reasonably sized home more inline with ERE or ER and THEN sell the mcmansion.

It's not a strategy for everyone, and it has it's risks, but I could see it's potential for me and others who see it fitting into their plans. Heck, my primary residence is a mcmansion to an extent and I've been pondering tapping the equity with a refinance, using it to buy another albeit smaller house paid in full, then selling my paid off rental and pocketing the cash. Then I would live in a paid off house without touching my cash savings (thanks to a wisely planned highly leveraged purchase that appreciated a lot last year), and when I sell my rental I get to pocket the cash for that too before the market cools down and it's not worth it anymore.

[jacob]

It's definitely interesting that while retail investors need to post 50% margin on stocks, they can get away by posting 20% on real estate, often 10% and when the government is involved even 1.5-2.5% margin on certain loans.

Now 2.5% is 40x leverage. If the market does go up, that's $$$$$$$.
But if it goes down by 2.5%, you just lost all your money.

[SimpleLife]

You can make a ton of money with this if you time it right, i.e., buy when everyone else is fearful and selling (or being foreclosed upon at 60% discounts), and sell when everyone else is joyful and buying.

If you do what a lot of people did which is watch from the sidelines for years then decide to buy when everyone else has been buying driving prices up for 7 years, then end up being forced to sell when the bottom falls out since you bought near all time highs, then it's not a good strategy. But who would do that? lol

But you didn't "lose all your money" if the bottom drops out, because you didn't put YOUR money into the deal necessarily and you haven't sold the house. You will just be forced to hold longer while the house recovers.

It's the timing and leverage that make this very powerful. To make money in stocks, you gotta have money. This is a way to make a lot of money using OPM (other peoples money) to buy sizeable real estate (1 large house in a nice area) without buying several average houses (multiple closing costs, investor status, capital gains taxes, etc.)

[ohcanada]

Hard to win when, on average, you're only matching inflation on top of averaging 1%/year in repairs, 2%+/year in property taxes. That's at least 3% out the window before considering inflation and looking for real returns on a non-productive asset...

[Scott 2]

So the strategy is:

1. Accurately predict the market low
2. Invest as much borrowed money as possible
3. Accurately predict the market high
4. Profit

Steps 1 and 3 are tough. Even if there are no repairs, the 6% broker cut, property taxes, insurance and mortgage interest make it even tougher. In a single year, you're down 10-12% before inflation.

[George the original one]

Let's play the game...

You have $507,751 to invest and you choose to follow this plan.
$500,000 house divided by 5 = $100,000 down payment
$7,751 closing costs paying points to get 4.000% rate on 30-yr mortgage (http://aimloan.com, perfect credit)
$5,000 annual property taxes (which is lowish for Portland, OR $500k home)
($1909.66 monthly mortgage payment x 12) + $5,000 taxes = $27,915 annual payment

That leaves $400,000 to invest. If you averaged 8% return, then you would get $32,000 annual income
$32,000 income - $27,915 expense = $4,085 annual income (ignoring mortgage interest deduction because the total income isn't high enough to be taxed!)
***
Version 2 - all cash
You have $507,751 to invest
You pay $257,751 to purchase a home mortgage free
Property taxes are $2600/yr
Invest the remaining $250,000 and average 8% annual return
$20,000 income - $2,600 taxes = $17,400 annual income
***

Version 3 - broker margin for (the risk taker)
You have $507,751 to invest
You pay $257,751 to purchase a home mortgage free
Property taxes are $2600/yr
Invest the remaining $250,000 plus $200,000 on margin (1.33% rate http://interactivebrokers.com) and average 7.5% annual return
$33,750 income - $2,660 interest - $2,600 taxes = $28,490 annual income

[SimpleLife]

@GTOO,

Isn't the first scenario incomplete and thus a bit skewed? You're leaving out the appreciation of the house as investment gains, instead only counting the non real estate invested cash as investment gains, and subtracting the mortgage from said gains for an adjusted figure. The whole point of the 500K house was as a leveraged investment. It's only fair to count the appreciation of the house as investment gains.

It would be a more accurate comparison if you counted the appreciation of the house over say, 2 years in addition to the money invested in the stock market. In my area, RE has appreciated 18.95% in the last 2 years. On a 500k house, that's $94,750.

Now add to that the $32,000 stock gains and you have $126,750. Now, if you want, you can deduct up to half of the mortgage payment from this figure. Why only half? Because you need a place to live anyway, and say you would live in a 250K house if it weren't for this house, then the payment would be considerably lower. In any case let's say about 14K. So subtract $14,000 from $126,750 is $112,750.

[Scott 2]

All 3 scenarios ignore the impact of volatility. When using leverage to invest in a single physical asset, it really really matters.

If turning a profit was this easy, the lenders would just go buy some houses with 18% return, instead of offering mortgages at 3% interest.

Reminds me of that Keynes quote - “The market can stay irrational longer than you can stay solvent.”

The catch with speculation, is when taking on big risk, some percentage of investors will make it big. What a great story. Nobody wants to hear about all the other guys that lost everything.

[RealPerson]

There is always a relationship between risk and return. It is how you get rewarded for taking a higher risk. Leveraging simply magnifies the returns and the risks.

The high cost of heating, cooling, paying taxes and maintaining a McMansion make this an even more risky proposition in my mind, because your investment will have significant ongoing expenses. Additionally, McMansions are difficult to rent out because people who can afford these can afford to buy their own house.

"I am more concerned with the return of my principal than the return on my principal" applies here as well.

[JohnnyH]

I was hoping this was going to be a good article because, excluding the current 48% YOY (my area) run-up in prices, I think mortgages actually can be a great idea... I would disagree with probably every point except 3, 4/5, 8/9.

Reason 1 & 2: Irrelevant semantics.
Reason 7: translation = double down with more margin.
Reason 10: Mortgages increase flexibility? Ridiculous.
Reason 11: Probably the dumbest one yet... You'll always have a monthly payment, sooo why care if it is $59 (my prop taxes + fire insurance) or $2500!

Reasons from OP for reference:
Reason #1: Your mortgage doesn’t affect your home’s value.
Reason #2: A mortgage won’t stop you from building equity in the house.
Reason #3: A mortgage is cheap money.
Reasons #4 and #5: Your mortgage interest is tax-deductible. And mortgage interest is tax-favorable.
Reason #6: Mortgage payments get easier over time.
Reason #7: Mortgages allow you to sell without selling.
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.
Reason #10: Mortgages give you greater liquidity and flexibility.
Reason #11: You’ll never get rid of your monthly payment, no matter how hard you try.

[Seneca]

It's definitely interesting that while retail investors need to post 50% margin on stocks, they can get away by posting 20% on real estate, often 10% and when the government is involved even 1.5-2.5% margin on certain loans.

Now 2.5% is 40x leverage. If the market does go up, that's $$$$$$$.
But if it goes down by 2.5%, you just lost all your money.

When we bought the house in 2012 we got a 95% mortgage as we had not closed the sale of our prior house, and for various other reasons at that time, wanted to hold on to as much cash as possible. It was not a FHA mortgage, simply traditional market financing. I was shocked you could still do it. We got market rate and no points, but we paid a few months of PMI until we sent them a big check to take our LTV under 80%.

I argued in the other thread I didn't think Americans were necessarily stupid for spending more on our houses than other nations, but this is obviously from a consumerist standpoint. Not an ERE'er.

We value freedom and simplicity in our finances a whole lot more than trying to make the spread up on a mortgage by using the money on other stuff. The goal to payoff the mortgage ASAP keeps us focused with our finances, and caused us to buy much less house than we would've otherwise.

The interest deduction has been under attack for a few years, there have been a few "it's only for the RICH BASTARDS" articles recently, and it seems to me the clamor is increasing. It's going away at some point.

[George the original one]

Isn't the first scenario incomplete and thus a bit skewed?

Of course it's incomplete. Whether it's skewed or not depends on how much it costs you to maintain a larger home (heat, furnish, landscape, etc.) and whether you have enough income to make use of the mortgage deduction.

The back of the envelope calculation suggests that an ERE person, someone who has left the workforce and is living on minimal income, should not go this route. If you have a high income, then you might be better off.

In my area, RE has appreciated 18.95% in the last 2 years. On a 500k house, that's $94,750.

My stock portfolio has appreciated 44% in the past two years. To me, both figures (your local home and my stock portfolio) are equally irrelevant as they don't describe long term market expectations across the nation.

Or, another way to look at it, how are you going to make use of that $94,750 today? Are you going to take out another loan against the equity (you can only get 80% of that number at a higher interest rate than your current mortgage) or are you going to sell the property (subsequent 7% transaction fee) and lose the opportunity at future property appreciation?

[George the original one]

All 3 scenarios ignore the impact of volatility. When using leverage to invest in a single physical asset, it really really matters.

My scenario 2 was all cash, no leverage!