The Mortgage Question

jennypenny · Post by **jennypenny** » Thu Jul 05, 2012 3:27 pm

I thought since we touch on this subject enough, maybe it should have it's own discussion. (then Jacob won't need a *third* journal)
Some issues that come to mind:

--I don't think a mortgage is different than any other debt. I know some people feel better when they own their home outright, but I've never understood putting feelings before hard calculations when deciding whether any debt is a good idea. (I think this also applies to student loans.)

--I do think a mortgage under 4% is cheap money, but I think my opinion is somewhat skewed by the fact that the first mortgage I held was 12%. It doesn't matter what historical rates have been. You have to do the math and see how cheap the money really is now.

--I've always valued cash flow/cash savings more than lack of debt as a way to FI. I know others think being debt free feels more independent.

--I think a mortgage might be useful in the case of a home-related emergency (like a fire or natural disaster). If the bank has a significant stake in restoring the property's value you have an ally when trying to settle with the insurance company.

--I think I like knowing I could walk away from my house if something dreadful happened to devalue the property and still have that cash in my pocket instead of sunk into the property.

secretwealth · Post by **secretwealth** » Thu Jul 05, 2012 6:44 pm

I think I'd mostly agree, although I've spent the past year paying off my mortgage instead of investing.
1. Mortgage is unlike other debt, but mortgaging a house to invest is like investing on margin. It is a good idea if you can get greater yield on your investments than your mortgage.
2. Any debt with a lower APR than inflation or the ROI on other investments is cheap money, and if I could refinance my apartment for 3% or below, I would do it in a heartbeat. My mortgage was over 6%, thanks to my low credit score. If it had been lower, I may not have paid it off.
3. While higher cash flow is good for float, if higher incomings are offset by higher outgoings, cash flow isn't necessarily a good thing.
4. Good point, especially in the case of single-family homes. However, it works the other way: if one has equity in real estate, it is a good way to diversify away from other investments that may lose value (bonds, stocks, etc.)
5. Another big consideration, but sometimes owning property will get you a substantial discount on renting in the same market, which offers additional savings. Manhattan is one such place, but I'm sure there are others.

George the original one · Thu Jul 05, 2012 9:10 pm

I'm pretty much in line with jenny's thoughts. When I'd rather have no mortgage are the following circumstances:
1) Self-employed - it's much tougher to get a mortgage in the first place and your income is likely variable.
2) Retired - why take the risk now that you are "set".
3) No knowledge regarding one's investing capabilities, so unable to evaluate using a mortgage as leverage. I think its possible that a young ERE candidate would fall into this category, but if you have 5 years of investing experience, then you're likely no longer in this category.

karim · Post by **karim** » Thu Jul 05, 2012 9:43 pm

Interesting discussion. One point though, jennypenny. Although you can walkaway form a house when it becomes devalued and are upside down on it, the money in your pocket is at risk when the banks chase after you after a foreclosure. So that's not really money in the pocket.
I do think that debt can be used effectively, but there is an element of risk that is hard to quantify.

Ego · Post by **Ego** » Thu Jul 05, 2012 11:03 pm

Home owners are often shocked to discover that after fifteen years they still owe most of the original loan amount because they have little understanding of how the loan is amortized.
Here's a good simple amortization calculator http://ow.ly/c2TJ8
Look at the total interest paid over the life of the loan. Yikes!

tylerrr · Post by **tylerrr** » Thu Jul 05, 2012 11:08 pm

@karim,
I thought of the same thing.....You could walk away if your house crashed in value, but the banks WILL come after every penny you own and recoup anything they can.
There may be ways to shelter yourself from that, but I doubt there are many ways...
And do you think the laws are written to benefit us? Or the Banks? You can bet your bottom dollar the banks have written most of the laws enabling them to go after your assets.
After owning one condo, I'm not sure i'll ever own again unless it's land bought in cash.
I love the freedom of renting and having no debt at all with super large savings in my bank account.

jennypenny · Post by **jennypenny** » Thu Jul 05, 2012 11:16 pm

>>There may be ways to shelter yourself from that, but I doubt there are many ways...

There are more ways than you think

I should have mentioned that DH feels VERY differently about this. He thinks "cash" is an elusive commodity at best and can be taken away at any time, but property that you own outright you can at least defend. He worries about a day when we wake up and our Vanguard or Wells Fargo accounts are empty without warning.* He feels electronic theft or confiscation is much easier (now) than physically taking possession of something.
*He scares me when he talks like that because that's his field so he knows how easy it is to do.
edit: I really made DH sound like a crazy prepper and he's not that at all. He just thinks (someday) when the government starts to run out of money, it will be much easier to skim off the top of people's accounts than take possession of "things."

Ego · Post by **Ego** » Thu Jul 05, 2012 11:58 pm

@tyllerr, "You could walk away if your house crashed in value, but the banks WILL come after every penny you own and recoup anything they can.
There may be ways to shelter yourself from that, but I doubt there are many ways..."
A few years ago there were a few stories about people who bought McMansions with no money down back when banks first started offering the no-proof-of-income loans. They held on for a few years then refinanced and pulled out the cash which they used to buy a much more moderate home in full. They then filed the homestead exemption on the new house, turned in the keys for the old McMansion and walked away with a fully paid home for the price of a few years of mortgage payments.... leaving the bank with no recourse whatsoever.

secretwealth · Post by **secretwealth** » Fri Jul 06, 2012 3:23 am

One more thing: a paid-off mortgage isn't a permanent loss of liquidity. You can turn that equity into cash with an HELOC at pretty low cost, if need be.

tylerrr · Post by **tylerrr** » Fri Jul 06, 2012 3:49 am

@Ego,
I do remember a few of those stories and my night is going much better now that I know banks get royally screwed sometimes.
I have a deep seated hatred of them...for real....

karim · Post by **karim** » Fri Jul 06, 2012 4:06 am

@ Ego: I thought the homestead exemption requires the death of a spouse.
@tyler: I agree that being debt free does give you more freedom. By having debt, you are a slave to your lender (simple peonage).
Jacob touched on this in a blog post:

http://earlyretirementextreme.com/how-i ... d-any.html

Christopherjart · Post by **Christopherjart** » Fri Jul 06, 2012 5:13 am

If the bank could go after you, then why is it that most recomend investing money after making minimum payments instead of paying down the mortgage right away? I'm very curious since I hope to buy my first condo or tiny home on the edge of the city in the next few years (hopefully by the time I'm 40 so I have 4 years to finish saving a big downpayment and to find a place.)

secretwealth · Post by **secretwealth** » Fri Jul 06, 2012 5:23 am

Debt recourse laws vary from state to state; in some parts of the country the banks can go after personal assets, in others they can only go after the house itself. Some people default and hide funds until the statute of limitations passes. It isn't impossible, but it is a legal gray area.

ToFI · Post by **ToFI** » Fri Jul 06, 2012 10:47 am

At the beginning of buying the first home, I felt the same with many people that we should pay off the mortgage ASAP so I made prepayment toward the mortgage now I regretted. My mortgage is variable 2.25%. To take out the money again by HELOC, it's 4%.

Now I made up the mind to delay paying the mortgage as long as the possible.

Being mortgage free gives your financial freedom is false sense of security. Financial freedom is passive income bigger than living expense. I am more concerned with cashflow and opportunity cost.Mortgage is only 30% of my mandatory living expense. Even if I commit most cash to pay off the mortgage, I still have other bills to pay and no incoming cash to pay for those bills so I am not FI. By having the cash invested instead, I can generate 7~15% ROI far better than getting 2.25% return from paying off the mortgage. People dislike risk which is perceived as fluctuation. To me, the real risk is end of world scenerio which nobody can escape anyway so there's no need to worry about.
Interest rises substantially? It just means the opportunity cost has changed. No problem, Maybe I can adjust asset allocation. By delaying paying off the mortgage in fact allows me to pay off the mortgage sooner. By not paying off the mortgage doesn't mean I'll waste the money on senseless purchases like big empty house and fancy car. It's either sitting in stock,bond or even cash, ready to be redeploy to somewhere else.
Bottom line: I think being house rich and cash poor/no investment is not a good thing.

karim · Post by **karim** » Fri Jul 06, 2012 3:03 pm

@Christopherjart: Some people advise you to invest rather than pay down your mortgage because you can make more money by investing (say 8%) versus pay down the mortgage (which for example is costing you 4%).
@ToFI: The problem is that the debt that you have (If you plan to keep it at retirement) is causing you to have a large nest egg. If say you are making $700 monthly payments for your mortgage, then you need an additional $280,000 saved to be Financial independent (this figure is likely less since you won't be making mortgage payments forever).
I find hard to equate financial INDEPENDENCE with debt. I don't think you are independent if you have debt--because you have an obligation to pay it off.
Also ToFI it sounds like you have an ARM, if you live in the US that is. If you plan to keep your mortgage around, it would seem reasonable to get a fixed rate mortgage, because the ARM interest rate is only going to go up.

Hoplite · Post by **Hoplite** » Fri Jul 06, 2012 4:22 pm

One aspect not mentioned here is whether the mortgage is assumable, i.e., whether you can transfer a low rate mortgage to a buyer in a later, higher interest rate environment. An assumable 30 year fixed rate mortgage in some ways is like holding a long term bond, only the valuation is reversed; higher rates mean the lower rate mortgage loan is more valuable, whereas low yield bonds fall in value.
And for jennypenny; a debtor's revenge using pennies:
http://www.dailyfinance.com/2012/07/06/ ... h-pennies/

jennypenny · Post by **jennypenny** » Fri Jul 06, 2012 8:55 pm

@Hoplite--haha, I'd love to do that. You should have seen the fit I had in my bank once because they refused to accept change for a deposit. (even rolled)

ToFI · Post by **ToFI** » Sun Jul 22, 2012 3:25 pm

@karim

no I dont need additional money to achieve FI if I delay mortgage as long as possible. The capitals that can be used to pay off mortgage are invested at a higher return than mortgage rate. They dont just disappear.. It's all about opportunity cost.for example, 2.25% vs 7~15%.
The current interest rate enviornment is unbelievable. It's benifiting borrower and penalizing saver. I am virtually borrowing for free after inflation
If interest rate goes up, I'll adapt.

karim · Post by **karim** » Sun Jul 22, 2012 4:58 pm

@ToFI

you are right, borrowing currently is dirt cheap and you will make more investing no doubt. I just come from a background of hating debt. There is also risk associated with using leverage that doesn't seem to ever be taken into account.
By the way, there is no "if". It should be: "When" the interest rates go up, I'll adapt.

ToFI · Post by **ToFI** » Sun Jul 22, 2012 6:29 pm

I treat mortgage differently than other debt.It's part of housing cost.

1.It's the cheapest way to borrow.

2.It's small part of housing cost.Mortgage payment is 41% of my housing cost and 31% of total living expense. Mortgage interest is half of that. Whether I pay it off or not, my liquid networth is increasing at the rate of 13% of my mortgage per year.In another words, I'll have enough liquid asset to pay off the whole mortgae in 7.7 years and 5 years with help of investment.It doesnt make sense to use all my liquid asset to pay off the whole mortgage to achieve 2.25% return.With paid off house and no liquid asset doesn't provide me financial freedom. I still have 60% of other bills to pay. If I plan to reduce the mortgage in the future,I"ll gradually increase fixed income investment.

3.I think of it like rent but it's better than rent because half of it goes to equity.

4.I look forward the rise in interest.That means some of my stock will benefit from higher interest and I can buy bond at cheaper price.

5.Risk is the result of ignorance.