Reasons To Carry A Mortgage

    Published: 06-16-2009
    Views: 13,723
    Financial advisor Ric Edelman explains why it’s important to carry a mortgage.

    Ric Edelman: Hi! My name is Ric Edelman. Many people don't understand mortgages, they think they're risky. The truth though is that mortgages are a great financial tool if you use them right. We're talking about the 11 reasons to carry a big long mortgage. Here are the first three.

    Number one, your mortgage doesn't affect your home's value; you thought your home would rise in value overtime, right. Well, guess what, your home's value will rise or fall regardless of whether your have a mortgage. And that's why owning your home out right is having money buried under your mattress. If you pay off your home all that equities tied up in your house where it's not earning any interest. Having a long term mortgage let your equity grow with your home's value.

    Reason number 2, a mortgage won't stop you from building equity in the house, mortgages are bad 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 with down payment of 50 grand. After 20 years of paying your mortgage, you'll evaded about a $100,000 in equity, that's a lot of money. But if your house rises in value with rate of 3% a year you'll have nearly a quarter million dollars in new equity. Even if your principal balance never declines.

    The 3rd reason to have a big one mortgage is this, a mortgage is cheap money, the cheapest money you'll ever be borrow in fact. Just compare the rate of a mortgage to that of a credit card, credit cards charge high rates because they've a higher risk of being repaid, they have no collateral, VISA can't repossess a sweater that you bought. But mortgages have collateral, your house, and that reduces the bank's risks, so that they can loan the money for much less and in much larger amounts.

    Reason number 4, your mortgage interest is tax deductible and reason number 5, mortgage interest is tax favorable. These two points are related, let me show you why. Interest you pay on mortgage is tax deductible up to at million dollars, the deduction is taken at your top tax bracket. If you're in the 35% tax bracket, every dollar you pay a mortgage interest saves you 35 cent in federal taxes. You save on state taxes too. Let's say you run the 25% bracket and your mortgage rate is 7% that means the loan cost you 5 and a quarter after taxes. And here is the best part, when you earn profits from investments those profits are taxed at only 15% maybe even less and that means if you invest money in earned 7% your profits are taxed at 15 that your after tax profit is nearly 6%, even if your investment earn no more than what you pay for the mortgage, you're still making a profit after tax.

    And here's reason number 6 mortgage payments get easier overtime. If you have a fixed rate loan the payment stays the same for 30 years, but your income will probably rise and that means relative to your income over time, your payment gets easier and easier.

    Reason number 7, mortgages allow you to sell without selling, if you're afraid that your home's value might fall you should sell your house before that happens, or at least refinance to get the equity out. Reason number 8 mortgages allow you to invest more money and to invest it more quickly. And reason number 9, mortgages allow you to create more wealth then you otherwise would.

    Let's say you make $300,000 when you sell your old house and ready to buy a new home for $500,000. Should you use all your cash and make a $300,000 down payment or should you place only 50000 down? With the bigger down payment your monthly payment will be $1300 dollars. But the smaller down payment though, it's closer to 3000 a month, so you think you should put down the 300 grand to get that lower payment? Not so fast.

    Choosing between the big payment and the small one is the wrong question, you should be asking if should invest $250,000 right now or 1700 a month for the next 30 years assuming an 8% return the larger investment right now will produce higher profits compared to investing slowly over the time, which means that while a loan mortgage payment lowers your overall expenses, it also lowers your overall wealth.

    Reason number 10, mortgages give you greater liquidity and flexibility. To help you understand this let's pretend that you and your neighbor are both buying a $250,000 house, you each makes 75 grand a year and you each have 50 grand in savings. Your neighbor hates mortgages, he takes out a 15 year loan with a fixed interest rate of 675 and uses his 50 grand as a down payment and then sends in an extra $100 a month to pay that sucker down even more. Unlike your neighbor you know that mortgages are a great tool, so you take out a 237,500 hour 30 year fixed rate mortgage at 7% and you invest the difference, you never make extra payments. Compared to you your neighbor has a smaller mortgage a shorter mortgage a lower interest rate and he's adding money to every payment. You've got a smaller payment though 1600 bucks, most of which is interest, assuming you're in the 25% tax bracket that means your payment cost you 1200 a month, you're neighbor pays almost 1800 a month. But less of it is deductable, his after tax cost is $1500 and this is where your smarts come through.

    Every month you pay $300 less then your neighbor, you invest that money, instead of sending the money to a lender with an extra 100 month you invest that too. And after 5 years let's say that you both loose your jobs, your neighbor has big problem even though he owes less on his mortgage balance he doesn't have any money in cash reserves to help and make his current payment, but you don't have that problem, with the money you invested every month and the money you invested in set of spending it on the down payment you've got a nice take of about 80 grand, assuming it a hypothetical 8% return on your investments. You can afford to make your mortgage payment for years even without a job, doesn't matter that you owe more one the total mortgage balance. When you keep control over access to your money you maintain liquidity, when you give your money to your lender you loose control, if you're giving money to your lender the only way to get the money back is to sell the house and no bank will let you refinance if you're unemployed with no assets. So stop listening to those who pretend but the only thing that matters is paying off your mortgage. Your life is more complicated then that and by realizing this you see that trying to pay off the mortgage is actually a risky thing to do, so instead the smarter safer approach is to carry a big long mortgage. Invest the difference and don't bother trying to be in a hurry to pay it off. Here is reason number 11; you'll never get rid of your monthly payment no matter how hard you try. You want to eliminate your mortgage so that you don't have to make any payments, well too bad. Because even if you somehow manage to eliminate your mortgage you won't eliminate your payments, oh! Sure paying off your mortgage means you no longer make any principle or interest payments, but mortgage payments are known as PITI and we've only addressed the P and the I, principal and interest. Let's not forget about the T and other I or the M and the R, I'm talking about taxes and insurance. Even if you manage to payoff the loan you still have to pay property taxes and home owner insurance, so your goal of getting rid of the mortgage payment is impossible and even if you eliminate the mortgage you still have to make taxes and insurance payments and as long as you run your house you'll have M and R too, Maintenance and Repairs. So, don't bother trying to make your mortgage go away, instead create wealth so that you can comfortably afford the cost of living and owning your home.