You Should Get a Mortgage!

2007-03-29 23:05 - Opinion

I've heard and read in various places and from various people that it's a good idea to get a mortgage. "You should get a mortgage!" they say. As I've said before, I plan to buy cash. Can I put some hard numbers behind it, to justify my decision?

To do so, I'd have to disclose my income and savings, which isn't terribly savory. I'd also have to know the target I'm saving for, which I don't. Not exactly at least. So, I'm going to make up some approximate numbers. They should be close. So, here's my made up numbers: $100,000 in savings and a $200,000 target goal, the price of a house.

Then I bring in some hard numbers and real math. I earn 5.05% in my savings account. The first compount interest calculator in Google says that over the course of one year, $100k at 5.05% compounded monthly results in a profit of $5,168.54. Not shabby.

On the other hand, the mortgage interest calculator that Google finds me says that a 15-year fixed mortgage can be had for 5.42%. If I assume a $100k loan to cover the price of the house over 15 years, it says that I will have paid $5,130.70 in interest over the course of the first year. (It also shows a monthly payment of just over my current monthly rent.)

So, in short, it's $5k paid out, instead of $5k brought in. Sure, I can "write off" those $5k lost, but all that means is I don't pay taxes on the income. This gains me about 1/3rd of it, or about $1700 dollars. All told, income lost, interest paid, taxes saved, it's $8,589 down over just saving the money. Then, once I own a house instead of renting, I have property tax, utilities like water and garbage, maintenance, and all sorts of other costs to deal with. Doesn't seem like a wonderful idea.

Invest it you say! The other "loan don't rent" camp says that you should save that money, and invest it. Get that mortgage for the tax write off and keep the investment income to boot. For some reason, 10% is the expected return on a good investment. Something tells me that's too optimistic, but let's go for it. Mortgage the whole thing, invest every cent you can get your hands on!

So, the interest would bring us $10,471.31 over the first year. The monthly payments on a $200k loan seem too high, so I have to stretch it out to a 30 year mortgage, at 5.70%. The montly payment is still 50% more than the earlier loan. Now, I'm out $11,332.86 in interest over the first year. This time we keep the investment interest, lose the loan interest, and gain a bit in writeoffs. All told, that comes to a theoretical $2,916.07 profit. But, it still incurs all the additional costs associated with home ownership that renting does not, as well as monthly payments 33% more than my rent.

Much worse, to me, it relies on the stock market. I've been burned once already. It might have been bad luck (late 90s and all), but I personally don't feel that the economy in the U.S. is really going to pan out over, oh, a 30 year period. The housing market is on the brink. Energy doesn't look too bright to me. I'm just not in the sort of position where I'll chose to rely so heavily on investment income.

So, where does my logic fall apart? I've neglected to take compound interest into account. If that 10% were to hold up, the result after 30 years would be around two million dollars. The mortgage interest over those years was $200k (doubling the cost of the house), which dents that a bit, but it's still a nice chunk of change. And I'm rambling. But my real point still stands: the only way to make getting a loan better than keeping your cash is relying on the stock market to give you a better return than you'll lose on the loan. Something I'm not comfortable with given these times.

Comments:

Rent?
2007-03-30 10:32 - kathaclysm

Ah, but your calculations don't consider what you are loosing to rent while you are waiting to have enough money to buy a house. If you aren't going to save enough money for a house for 5 years, that's 5 years of money that went to rent instead of 5 years of money that went to interest, that you could have been writing off.

Plus, you probably could pay more than minimum on a mortgage. On our mortgage, any extra we put in a month goes to the principal, not interest, so it is highly beneficial to pay a bit extra each month.

One more thing...
2007-03-30 10:37 - kathaclysm

You have also neglected inflation & appreciation. If you buy a $200k house now, in 20 years, you will still be making the same payment, but inflation may render that you are actually paying less. Also, a house appreciates in value, so it is a sort of investment on it's own.

The main reason I'd hold off on buying a house if I were you though is that the housing bubble is popping, and prices are due to drop a bit in the next 2 years as people foreclose on their poorly planned ARM loans and such. That would be the ideal time to buy; when people are desperate to sell.

Rent = Lost?
2007-03-30 10:43 - arantius

I used to think that rent money was lost money. When I first moved out on my own, into an apartment, my only real goal was to get a house. I figured, rent paid is lost. Sure, I have a place to live, but when the lease is up, I've paid out money but don't have anywhere to live anymore! Paying a mortgage seemed better at the time.

But, in my best-case (lowest payment) situation above, the monthly payment on the mortgage was more than my current rent. And, when renting, I don't pay for water, or garbage service. I don't pay for maintenance, and I don't pay for property taxes. How much do those all add up to? A heck of a lot, I bet. Sure, technically, I pay for it. It's a factor in how much the rent is. But, it's money above the already-higher mortgage payment that would go into home ownership. So, how much money is lost to owning? I didn't run the numbers (because lots of them I don't know) but my intuition tells me probably just as much as is "lost" to renting.

Long story short, yes, owning has long term value. The fact that a house appreciates while cash depreciates due to inflation is big. But for my situation, waiting just a couple years will put me well within range of a potential purchase. Perhaps well above, if the market crashes hard enough.

On the very other hand, though, I've gotten used to apartment life. It's nothing super decadent, but I'm actually just fine as I am in my studio apartment. Do I really want to have a two story eight-or-so room house? Do I need it?

buy or rent
2007-04-11 13:18 - bobdionne

http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?_r=1&oref=slogin

Very nifty!
2007-04-11 13:55 - arantius

Thanks Bob, that is a very useful little applet. It confirms my suspicions that from a purely money standpoint, owning isn't a very good idea. I'll just need to hang on and see if housing prices drop soon, I've heard that foreclosures are starting to crop up like weeds.

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