from How the Affluent Manage Home Equity to Safely and Conservatively Build Wealth
- Both earn $75,000 a year
- Both have $50,000 in cash
- Both buy a $250,000 house
Nick wants to minimize his mortgage, so he uses his $50,000 in his savings as a down payment and he opts for a 15-year loan at 6.75 percent. His monthly payment is $1,770 — but only 74 percent of that payment is tax-deductible interest; the rest in principal. Therefore, Nick’s net after-tax cost for his mortgage is $1,489. And to pay off his mortgage even quicker, Nick sends in an extra $100 with every payment. Of course, these payments are devoted entirely to principal, and therefore provide no tax deduction.
Nick’s decision to send extra payments to his lender is a critical point. You see, every time you send extra money to your mortgage company, you deny yourself the opportunity to invest that money else ware.
Sam understands this and therefore he obtains a 30-year mortgage at 7 percent (a bit higher than Nick’s rate). He puts down just $12,500 and finances the rest. Even though Sam’s mortgage balance is bigger than Nick’s ($237,500 compared to $200,000), his monthly payment is lower (because it’s longer term). That’s not all. A full 88 percent of Sam’s payment is interest, meaning that Sam’s after-tax cost is just $1,234 a month — $255 less than what Nick has to pay! Sam invests this savings of $255 each month for five years, earning 8 percent after taxes per year. And, instead of sending an extra $100 a month to h is mortgage company, as Nick does, Sam ads it to his savings.
Over five years, Sam has about $79,000 in savings and investments. Nick, however, has no cash whatsoever, because he’s places every available dollar into mortgage payments. So, when both men suddenly find themselves out of work, Sam is in excellent financial condition, but Nick is in real trouble. He has no savings to tide him over and he can’t gain access to the $100,000 worth of equity that’s in his house because the bank turned down his loan application since he was out of work. Indeed, Nick has fallen victim to the biggest misconception in real estate; A mortgage is not a loan against the house: it’s a loan against your income. Without an income you cannot obtain a loan.
If Nick doesn’t get a job real soon, he’ll loose his house. How ironic! Nick, who never wanted a mortgage in the first place and did everything he could to eliminate his mortgage as quickly as possible, is now in serious financial jeopardy! Sam, though, is in much better shape. With $79,000 in savings, he’s easily able to make his payments each month. in fact, he can make mortgage payments for four years, giving himself plenty of time to find a new job!
And that’s really my point. When you have a mortgage, you are required to make only that month’s payment.
Ok, you’re convinced. You agree that a big, long mortgage is best. But how do you act on this advice? It’s simple. Go get a new mortgage! Either refinance, replacing your current loan with a new, bigger mortgage, or get a second mortgage to supplement your existing loan. Which is best? It depends on whether you can get a new loan with better terms than your current loan. Talk to a Mortgage Planner to find out.
So, what are you waiting for? Get a big, long-term mortgage today!