I promised to bring you ideas in this newsletter — and in my work with you — that are uncommon points of view. Here’s one of those topics. Mortgages are most often discussed, and sold, in terms of their “per month” cost. I prefer to position mortgages as wealth-building instruments, not just as an ends to a mean (i.e., homeownership), that fit into your available cash flow. Lower home values and today’s low interest rates can create great opportunity for wealth creation when you keep in mind the following keys to real estate investing.
Consider total interest cost.
Too often, discussions about mortgages revolve around how much you can stuff into your monthly cash flow. For example, every $100,000 of mortgage at 4.25% over 30 years will cost you $77,098.40 (monthly payments of $491.94), whereas a 15-year term, at 3.75%, will cost you $30,899.60 (monthly payments of $727.22). If your goal is to build wealth, consider the total interest cost and not just the monthly payment.
Understand how taxes reduce your cost (or not).
Most mortgage interest expense is still tax-deductible for federal and California income taxes, although there is some discussion about limiting this deduction further. Don’t be surprised if “high-earner/wealth” limitations apply to you. For every $100 of interest income you deduct, you save $43 in income tax if you are in the highest tax brackets (and you haven’t hit any AMT or itemized deduction limitations). You are still paying $57. And, on the other hand, if you don’t exceed your standard deduction, there is no tax benefit for mortgage interest. Although mortgage interest deductions reduce the cost of this investment, there is still a considerable expense, even at the highest income tax brackets.
Use a mortgage to hedge inflation.
Housing costs are typically a large part of one’s monthly expenses and are often subject to high inflationary pressure — unless one has a fixed-rate mortgage, a great hedge against inflation. According to the National Association of Realtors, the price of rent increased 200%, tuition, 697%, and a home, 150%, over the past 30 years. Compare that to the homeowner who had a fixed mortgage (0% inflation). If you buy a home today and lock in a fixed mortgage payment, you ensure you will have 0% inflation on your house payment over the next 30 years!
Picture a time without a mortgage.
Mortgage payments can be fixed. Portfolio returns and interest rates are not. This consideration is often not factored into financial planning advice that suggests you fund investment accounts over paying down your mortgage because, on average, the stock market yields a higher rate of return than mortgage interest rates. On average, yes, but what happens when you need to dip into your investments to make a payment during a “down” market year? You may erode your portfolio prematurely. Rely too much on retirement income such as Social Security, pensions and annuities (lifetime income guarantees, but with very low, if any, cost-of-living increases), and you may not keep up with inflation. These benefits are also cut or reduced at the first spouse’s death (mortgages, however, are not). Plan to pay off your mortgage before you retire, in balance with making contributions to your retirement accounts.
May I Introduce you to…
If you think homeownership or refinancing may be right for you, I’d like to introduce you to mortgage professional Martha Shanks. Many of my clients already know her. I highly recommend Martha because she is knowledgeable, efficient and highly ethical. I’ve only received extremely positive feedback about her.
I’ve asked Martha to share her most common client questions and answers to clear up some confusion about today’s financing world. One Q&A appears here; you’ll find more on my website. Thank you Martha.
Besides an FHA loan, what else is available for a buyer with very little down payment?
You’re in luck. The 5% down conventional loan program is great for first-time homebuyers and repeat buyers alike. Unlike FHA, there is no upfront mortgage insurance (MI) premium (now 1.15% of the loan amount). And the monthly MI payment is generally about one-third less than the FHA’s. The requirements for opting out of the monthly MI are much less stringent (FHA requires a minimum of five years of mortgage payments). Use of gift funds is still available with the 5% down conventional loan program. And you can select a loan program in which no monthly MI payment is required. Contact me to get a good understanding of the credit, asset and income requirements.