Personal Finance (Sec. 3.3)

FUNDAMENTALS OF FINANCE

A Guide for Helping Professionals

Adam J. McKee


SECTION 3.3: Mortgages


If you are going to live in a particular place for more than a couple of years, renting is flushing money down a toilet.  You may get stuck renting if you have no credit or bad credit, but a major life goal should be to stop renting and buy a home.  The reason is simple:  Money you put into a house as principal usually maintains its value (unless you buy into a rich neighborhood that declines).  Of course, this is ultimately a lifestyle choice.  If you are willing to pay a premium for never having to mow a lawn, never having to replace an appliance, or never having to hire a maintenance contractor to fix a furnace, then renting may be for you.  If you are exceptionally frugal and are willing to live a Spartan lifestyle, you may be able to rent cheap enough and invest the savings in such a way that it is advantageous to do so.

A mortgage is a special kind of loan that you use to buy a house.  Because these loans tie up an incredible amount of money for a very long time, you want to put a lot of time and energy into getting the absolute best one you can.  You also want to look for value when selecting a home to buy.  Some folks just can’t help wanting to look rich and live a luxurious lifestyle.  They buy way more house than they can afford, and they end up suffering the negative consequences of that bad decision for most of their working life.  Save yourself from this pain!  Buy yourself a comfortable house that has a comfortable mortgage payment and you’ll never regret your dedication to value!

Mortgages are debt, and are thus inherently evil.  These loans, however, are among the least evil.  Even debt-destroyer Dave Ramsey will (grudgingly) let you get a mortgage, so long as you look for a great interest rate, make the maximum down payment you can possibly afford, and extend the loan no longer than 15 years.

Some of the downside to paying off a mortgage is offset because when you are buying a house, you are investing in an appreciating asset that will grow in value over time.  Even those that think they can’t afford to invest in other investment vehicles (stocks, bonds, and so forth) are willing to invest in real estate because of the necessity of having a place to live and the emotional pushes to “own a home.”   Sadly, for average Americans, family homes are their greatest storehouse of wealth.  It is not uncommon for a house to double or triple in value over the life of a thirty-year mortgage.

Fixed-rate Mortgages

Fixed-rate Mortgages have a rate of interest that is set by contract and that never changes over the life of the loan.  This is the most common and most “traditional” type of mortgage; it is what comes to mind when most people think about a mortgage.  To my way of thinking, if you must have a mortgage, then you want a fixed rate mortgage with a repayment period of 15 years or less.

Is the Family Home an Investment?

You are sinking a huge amount of capital into a home if you buy one, so it is definitely an investment.  Just know that for most people, it’s not a very good one.  Homes generally serve as a good inflation hedge, but that is about it.  When you think of the stories you’ve heard about people making a killing because of capital appreciation, consider how long they held the asset and what compound rate would be necessary to generate the return.  Unless you are in a bubble zone, you will likely find that the compounded rate necessary is around 2.5%, somewhere in the neighborhood of inflation.  In that respect, homes are a commodity, regardless of your precious memories.

 

References and Further Reading

You can delve deeper into what makes up your credit score by visiting MyFICO.com.

Dave Ramsey is brutal about taking on student loan debt and credit card debt, but he is a little softer on mortgages:

To understand the difference between the bad debt I preach against and “good debt” that builds cash flows read Rich Dad Poor Dad.  Mr. Kiyosaki thinks that buying homes with borrowed money is an excellent idea, so long as those homes generate cash flow.


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