Many people misunderstand or misrepresent the benefits of mortgages, and they get the key points wrong. Many recommend you pay off your mortgage as soon as you can, but Edelman Financial recommends you carry a big, long mortgage and not try to pay it off early. Here are five reasons why:
Reason #1: Your mortgage doesn’t affect your home’s value.
You’re buying your home because you think it will rise in value over time. (Admit it: if you were certain it would fall in value, you wouldn’t buy it — you’d rent instead. In fact, your home’s value will rise and fall many times during the next 30 years — you just won’t get monthly statements showing you how it’s doing.) Yet, the eventual rise (or fall) in value will occur whether you have a mortgage or not. So go ahead and get a mortgage. Your house’s value will be unaffected.
That’s why owning your home outright is like having money buried under a mattress. Since the house will grow (or fall) in value with or without a mortgage, any equity you currently have in the house is, essentially, earning no interest. You wouldn’t stuff ten grand under your mattress, so why stash $400,000 in the walls of the house? Having a long-term mortgage lets your equity grow while your home’s value grows.
Reason #2: A mortgage won’t stop you from building equity in the house.
Everyone wants to build equity. It’s the main financial reason for owning a house. You can use the equity to help pay for college, weddings and even retirement. Many people say mortgages are bad because they lower equity.
They’re wrong, and here’s why. Say you buy a house for $300,000 and you get a $250,000, 30-year, 4 percent mortgage. Your down payment ($50,000 in this example) is your starting equity, and you want that equity to grow, grow, grow.
The figure in the gallery shows what happens: by making your payments each month, your loan’s balance in 20 years will be just $117,886. This supports the contention that equity grows as you pay off the mortgage and that, therefore, the faster you pay off the mortgage, the faster your equity will grow.
But this thinking fails to acknowledge that this is not the only way you will build equity in your house. That’s because your house is almost certain to grow in value over the next 20 years. If that house rises in value at the rate of 3 percent per year, it will be worth $541,833 in 20 years! You’ll have nearly a quarter-million dollars in new equity even if your principal balance never declines!
Reason #3: A mortgage is cheap money.
Mortgages , in fact, are the cheapest money you will ever be able to borrow. (Oh, sure, you can get a credit card that offers zero percent interest for six months, but try borrowing a couple hundred-thousand dollars for 30 years that way.)
You get a loan when you demonstrate you have the ability to repay it, but how much interest will you have to pay? The more confident the lender is that it will get its money back, the less interest it will charge you. By offering your house as collateral, you agree to let the bank have your house if you don’t repay the loan. This dramatically reduces the bank’s risk, resulting in a very low interest rate.
Reasons #4 and #5: Your mortgage interest is tax-deductible. Moreover, mortgage interest is tax-favorable.
These two points are related, and together they offer you important benefits to carrying a mortgage.
The interest you pay on loans to acquire your residence (up to $1 million) is tax-deductible. You take the deduction at your top tax bracket. Thus, if you’re in the 35 percent tax bracket, every dollar you pay in mortgage interest saves you 35 cents in federal income taxes. You save on state income taxes too.
Wondering if homeownership is right for you or if you should refinance your home? Talk with an Edelman Financial Planner. We’ve already helped more than 31,000 clients across the country* — and we’re ready to provide you with the independent, financial advice we provide all our clients.
Advisory services offered through Edelman Financial Services, LLC. Securities offered through EF Legacy Securities, LLC, an affiliated broker/dealer, member FINRA/SIPC.
*As of 12/31/2016