What are the negatives of a long term Mortgage?

April 25, 2005 12:39 PM

I just read an interesting article regarding long term mortgages. Basically fixed rate, 30 yrs = Good. 15 year = bad. What are some counterpoints to this argument. Drawbacks to long term mortgages? Advantages to paying it off early?

From the article:
The New Rules of Money are clear: A big, 30-year mortgage is the best thing you can have. You should get as big a loan as possible, and never pay it off. Forget about 15-year loans, never make extra payments, and forget about those bi-weekly mortgage payment plans.

posted by rschroed to work & money (20 comments total)

I agree with the article with two (large) caveats:

a. This works if you're where you plan to be for a while. The example of the person who bought in '59 and by the mid '70s was paying a pittance only works because he didn't move -

b. This works if you save that extra money. I know I'm not (though we're getting better) and I'd imagine few are.

The idea that you can do better investing money rather than paying down a mortgage more quickly is generally sound, as long as you, well, actually invest the money (e.g. a vacation and a larger SUV are not "investments").
posted by jalexei at 12:56 PM on April 25, 2005

Oh, Ric is absolutely right. You shouldn't be sending in that extra $100 towards your mortgage every month, you should be investing it... with Ric.

And since when is there a change in federal law that says banks can't call mortgage loans? Was foreclosure outlawed and nobody noticed?

Look, I don't begrudge folks trying to market their business, but I really do mind the ones that are so transparently trying to take advantage of folks who are less educated.

As for the length of your mortgage, it's really tied to your individual comfort level with risk.
posted by vignettist at 12:58 PM on April 25, 2005

I smell bullshit....just look at the amount of interest that accrues on a 15 year mortage versus a 30 year mortage.
The tax write off for interest payments isn't large enought to offset that much interest.

Here's the crux of his argument:

"Invest the proceeds of your refinancing carefully. Do not spend the money on vacations, furniture, cars or college. This is your home we're talking about, so you must invest these assets prudently. If you don't know how to do that, hire a professional advisor to do it for you."


Guess who happens to be a professional investment advisor?

Basically, he's making a big assumption....that people have the self control not to spend, spend, spend when they have a lump of money sitting there. He's advocating, borrowing as much money as possible against your house and investing it elsewhere.
posted by cosmicbandito at 1:10 PM on April 25, 2005

As far as you are concerned, you are a risk-free borrower-- of course you're not risk-free to the bank (but we don't care about the bank). If you can lend at a greater (after-tax) rate than you borrow, you win.

However, unless you manage to find US Treasuries that pay a bigger yield than your mortgage (and you can perform some kind of cash-flow matching and/or immunization), then this is not a risk-free endeavor. You can use stocks or corporate bonds, in which case you're playing a bit of a carry trade, which usually works, except for when it doesn't. In other words, you're assuming a bit of risk.

Complicating the matter is the state tax-deductibility of treasury interest.

On preview: And since when is there a change in federal law that says banks can't call mortgage loans?

Banks can't call mortgage loans unless the payer defaults. You knew that, though. You're picking nits.

Also on preview, I'd like to introduce to the time value of money, bandito...
posted by Kwantsar at 1:11 PM on April 25, 2005

Vignettist - calling the loan early is different than foreclosure, though. This article pretty much assumes you're never going to NOT pay. It also assumes that your income is going to continue to increase.

Really, the article is about the time-value of money, isn't it? If you had a 30 year mortgage, you could dump extra money into it and pay it off in 15, and then pay your mortgage payments into investments. Or you could contribute the extra money to investments from the start - either way the same amount of money is going out the door. The difference is what you have in the end. The compound interest you earn by starting early should make investing early a good bet.

But really, it is about your risk tolerance. My parents paid their mortgage off early becuase my dad retired early, and the mortgage was the single biggest expense. Sure, they could have kept paying it, but it gives my mom a great deal of comfort to know that they'll never have to worry about paying it.

I wonder if really, really rich people carry mortgages.

On preview: what kwanster said.
posted by dpx.mfx at 1:17 PM on April 25, 2005

What this article doesn't take into account is that by paying extra on your principle you are increasing your equity in the property. When it comes time you sell the house, you'll get a fatter cheque 'cause you'll owe the bank less money. Of course, that's a one-to-one ratio of "investment" to "equity" so you're not making any money on the "investment" but you're not loosing any money either.

This however is absolutely idiotic: "...every time you turn left, you deny yourself the opportunity to turn right. So while paying off the mortgage saves you interest, you deny yourself the chance to earn interest."

Well, likewise, every time you turn right you deny yourself the opportunity to turn left. Duh! If you can beat or want to take the chance you can beat 8% or whatever your current mortgage interest rate is, then invest the money somewhere other than in your property. If you don't want to take the chance, or don't think you can beat the rate, then put that extra money into your property.
posted by pwb503 at 1:22 PM on April 25, 2005

I wonder if really, really rich people carry mortgages.

Absolutely. I work in the mortgage industry. I've seen multi million dollar ARM mortgages at 3.5% (remember, that's an adjustable rate). I assume they bother with a mortgage because they have other investment opportunities for the money with higher rates of return than the mortgage interest.
posted by de void at 1:33 PM on April 25, 2005

The article is right if and only if:

(1) you have a fixed mortgage--I know this is obvious, but most folks (especially young folks) do not have fixed rates;

(2) you think you can make investments that will return more than your fixed mortgage rate;

(3) you think you have the discipline to make those investments and not blow the money on consumption;

(4) you think your house will appreciate in value and that there will not be a housing bust;

(5) you think that there will be inflation rather than deflation in the future.

The whole thing about the depression and banks calling loans is a red herring. People don't pay off their mortgages because they think the loan will be "called." They pay them off because people are risk adverse and hate having huge debts hanging over their heads.

Also, you should run away from anyone that starts talking about about the "New Rules of Money." There are no new rules of money; only really old boring ones that most people ignore (i.e., save money; don't chase hot investments; work hard; keep your costs low; etc.)
posted by Mid at 1:51 PM on April 25, 2005

Ed, though, is in much better shape. With $40,000 in savings, he's easily able to make his payments each month. In fact, even if he doesn't find work for a long time, his home is not in jeopardy. At the rate of $586 a month, Ed won't run out of money for nearly eight years!

this is only slightly misleading...doesn't he have to buy food while he's out of work for 8 years?

this guy's making all the same arguments that bush is making for social security: you'll ALWAYS earn 10% in stocks so it's a no-brainer to put your money into the market rather than paying into social security / paying down your mortgage. Duh!
posted by jacobsee at 1:52 PM on April 25, 2005

he's also making an argument about the liquidity of your alternative investments, saying that if you need the money later, it's better to have it somewhere you can get to it rather than in equity in your house. but isn't that a trade off between the liquidity of your investment and the potential return? and what if the market is way down just when you need the money? and you don't want to dump all your savings into a safe but non-liquid 15-year CD or someting either.
posted by jacobsee at 1:56 PM on April 25, 2005

The idea that you have to have a mortgage to borrow against is ludicrous. Let's say it's 20 years out, and I need to borrow some money. How do I do so, without paying credit card usury?

Simple. I get a second mortgage. But wait, I own my house outright. What do I do now? Well, I get a loan secured by the equity in my house. Anybody want to guess what they call this.

Another thing. The interest deduction between a 15 and 30 year loan may not be huge, but it is significant. If it knocks you into a lower tax bracket, though, it is huge, and it remains huge until you earn enough that the extra deduction doesn't shift your brackets. This is a critical calculation to make in loan terms -- I know someone who got a 10 year term, because he did the paperwork, and show the difference in net income to the loan officer. (He also paid it off in 5, spending one year in a higher bracket before the loan cleared.)

Finally, all of the above is only true in a flat or appreciating real estate market. In a declining market, being on the long end of a long loan means you have three choices -- pay inflated rates to own your home, buy out the loan, if you can afford it, or walk away and take the credit hit.

Given the current economic conditions, I think buying a home for economic reasons in most places is stupid -- it'll be half the price in five years, if you still have a job and can afford a house. It will also be much harder, as surviving lenders will be *much* more strict about who they lend to right now. If you want to for other reasons, getting and staying above water will be critical -- and hard to do as the bubble bursts. The only way to do that is to have cash equity in the property -- that means a real down payment, a short term, and pumping extra money into the loan at every gap.

If you don't believe that there's a housing bubble, or that the current credit practices of the US consumer and government are unsustainable, then, by all means, front load -- hell, get an interest only loan! Why even *pay* principal, when you can invest it, since you don't get the deduction.

Personally, if you aren't sitting on at least 50% equity, at current valuations, I think you should be seriously looking at selling while the market is good and getting into a house that you can clear quickly, if the credit crunch happens.

Finally, for Ghugle's sake. If you are sitting on an ARM or a interest only loan, it's very close to too late to fix this. Your best bet is to sell, stash the equity profit, if any, and wait for the bubble to burst. You should have refinanced two years ago, and if you signed a new ARM, you were hoodwinked. ARMs make sense only when interest rates are high.

If you're sitting on a 15 or 30 year fixed loan, with 50% cash equity, you'll probably be okay.
posted by eriko at 1:57 PM on April 25, 2005

If it knocks you into a lower tax bracket, though, it is huge

You understand, I hope, that getting "knocked" into a higher bracket affects only marginal dollars. Sometimes as few as one dollar. So it's extremely possible that bracket shift is entirely irrelevant.
posted by trharlan at 2:05 PM on April 25, 2005

I find his arguments fairly compelling if you have the discipline not to spend the money you save by minimizing your monthly payment. Basically, because you can deduct the interest you pay on your mortgage, you are only paying taxes on the difference between what you earn on your investments and what you paid on your mortgage to get the money you've invested. And your property is appreciating in value the whole time, so you're making money there too.

Sure, if "the bubble bursts" in the next few years you may temporarily lose some of your home's value. No biggie, as it's only a paper loss anyway. Over the next 20-30 years it will no doubt make that up and then some. If you are not planning to stay in a house for a couple decades, then pehaps you shouldn't be buying a house anyway. There are better investments than real estate over a 5-10 year time frame.

I personally hate being in debt, but that article has given me much food for thought. It's a truism that the best way to make money is to use other people's money. Why not your bank's?
posted by kindall at 2:43 PM on April 25, 2005

Without any personal slight intended: eriko, there is a lot wrong in your post.

The tax bracket thing has already been pointed out. Marginal tax rates. Getting a 15 or 30 year mortgage based on a "tax bracket" makes no sense.

Also, long-term mortgage rates are actually really low right now. It is not at all too late to jump from an ARM to a long-term. In fact, the rates are about exactly what they were two years ago.
posted by Mid at 2:50 PM on April 25, 2005

You should run away from anyone that starts talking about about the "New Rules of Money." There are no new rules of money; only really old boring ones that most people ignore (i.e., save money; don't chase hot investments; work hard; keep your costs low; etc.)

Excellent. That's all you really need to know about this huckster.
posted by JackFlash at 3:25 PM on April 25, 2005

Another reason that I call bullshit on Mr. Edelman: suppose you're 50 years old right now. Do you really want a loan where you'll be making the same payment when you're 75? In other words, he is assuming you'r income will continue to rise, throughout the entire term of the loan. If you're over 35, that probably is not the case.
posted by Daddio at 4:06 PM on April 25, 2005

damn, pesky work got in the way of reading metafilter again!

Yes, Kwantsar and dpx.mpx, you're right, and I did know that. Posted too fast for my own good.

Still though, this is not a guy I would pay to advise me.
posted by vignettist at 5:10 PM on April 25, 2005

As far as you are concerned, you are a risk-free borrower-- of course you're not risk-free to the bank (but we don't care about the bank).

This means that the bank is loaning you the money at an interest rate premised on there being more risk than there actually. Which means not a good deal for you, if the bank's assumptions about risk premiums and the time-value of money and all that are correct. Which means pay your mortgage as quickly as possible, unless you think you can do better than the bank at making investment decisions.
posted by sfenders at 7:06 PM on April 25, 2005

fascinating.

we made our final mortgage payment just about a year ago. it's sad to think that this news reaches me so belatedly; i'm now left out in the cold, at least as far as ric's money making schemes go... all my family and i have to show for our pay-off efforts are: a roof over our heads that costs us only utility bills and county taxes, full ownership of all our home's equity, and the rather relaxing feeling that, should it all hit the fan someday soon, we could probably make ends meet with a job at taco bell paying the bills...

perhaps i'm not the smartest person, money-wise, but i'm content in my unindebtedness.
posted by RockyChrysler at 9:09 PM on April 25, 2005

I've known people who refi'ed or got a 2nd mortgage to invest, and the results weren't pretty. The article doesn't factor in the costs of investing. Don't pay down the mortgage unless you've already got savings for contingencies. It's useful to have an equity line of credit, so if you get laid off, you've got a cushion.

Many people don't have the discipline to invest; a mortgage can be a form of enforced savings.
posted by theora55 at 10:05 PM on April 25, 2005