11 Reasons to Carry a Big Long Mortgage - Reason 8 & 9
This article has been around since I was originating loans and it was recently updated on Ric's site. I thought I'd take each one of his comments as a single post and share a few comments for those of you not familiar with this article or Ric's original claims about keeping the biggest and longest mortgage you can afford.
"His words in Blue", my words in white. I'll deconstruct his key points.
SHOULD I PAY OFF MY MORTGAGE?
11 great reasons to carry a big, long mortgage.
Ric Edelman – Edelman Financial Services
REASONS #8 AND #9: MORTGAGES CAN ALLOW YOU TO INVEST MORE MONEY AND TO INVEST IT MORE QUICKLY. Mortgages can allow you to create more wealth than you otherwise would. These two points are related, and together they offer you important benefits to carrying a mortgage. As mentioned in Reason #6, people get big mortgages on their first home simply because they don’t have a choice. You’re excited about buying a house, and even though you don’t have much money, you have a good income (or two). Some years later, with a growing family, higher incomes and newfound equity in the house, you’re ready to move up to a bigger home. Let’s say you net $300,000 from the sale of your old house and you’re ready to buy a new home for $300,000. Should you use all your cash and make a $300,000 down payment? Or should you place only $60,000 down, which is 20% of the purchase price? If you use all of the $300,000 to buy your new home, your monthly mortgage payment would be zero. If you make the smaller down payment of $60,000, your monthly mortgage would be $1,011, assuming a 3%, 30-year mortgage. This explains why so many people prefer to make big down payments when they buy houses. A big down payment translates to a small monthly payment (and in our example, the monthly payment would be zero).
TOTALLY AGREE: People live lives of cash flow, and wealth is a secondary consideration. Most people can't really imagine what their future self will look like, so they focus on today and today a $1,011 payment sounds a lot worse than a $0 payment - that today decision overwhelms the impact that $240,000 difference has if it's located in the house or located somewhere else.
But the people who are trying to ask you to choose between big monthly payments and small monthly payments are posing the wrong question. The correct question is not about the amount of money you want to pay monthly, but the amount you want to invest. Again, it’s all about wealth creation, not debt elimination. Would you rather invest: $240,000 right now, as a one-time-only deposit Or $1,011 a month, every month, for the next 30 years? Obviously, you’d prefer the strategy that results in a higher profit. Everything being equal, regardless of the time period, investing a large amount now can produce better results than investing small amounts over long periods. Thus, while a low mortgage payment lowers your overall expenses, it also lowers your overall wealth.
TOTALLY AGREE: Time value of money is that a large payment made early will earn more than a stream of small payments over time. If you invest $100,000 now that money starts to compound today, whereas an investment of $1000, over 100 months means it takes longer for that money to grow. Much of investment is psychology, and I'd rather have a consumer make a single well intentioned decision (invest $240,000 today) than have to make 360 decisions over 30 years to keep saving $1,011 each month (they won't).
Source: BorrowSmart Simple Saving Calculator - $240,000 invested for 30 years at 8% after tax
Source: BorrowSmart Simple Saving Calculator - $1,011 per month invested for 30 years at 8% after tax
This is why liability management is so HUGE - the entire house was $300,000, but this advice is worth $1,130,184.66.
But in order to invest that $240,000, you’d have to be willing to accept the higher monthly payment. Where will you get the money to do that each month? You’ll find the money from two places. First, increase your paycheck. Remember that the new loan payments are almost entirely tax-deductible interest. That means you don’t need to have as much money withheld from your paycheck. Ask your tax preparer how best you can file a new IRS Form W-4 at work to increase your exemptions; this will reduce the amount of taxes that are withheld from your paycheck, boosting your net pay. Yes – you’ve just given yourself a raise! And you can use this increased paycheck to help you pay for your new mortgage payment.
PARTIALLY AGREE: The W4 adjustment is one of 'the most powerful' tools to help with income, but understand this was to offset the tax savings, and per our prior post on Reason 4-5 - this will increase their income now, but it will potentially cost them more in taxes at year end given that their tax deduction doesn't increase to offset the higher monthly income just because they bought a house, and in this case the $300,000 house is not going to take their interest payment high enough to get them beyond the standard deductions.
Second, if your paycheck isn’t enough, simply make periodic withdrawals from the investment account you’ve just created. Soon enough, as your income rises, you won’t need this crutch; your income will become enough to handle the cost, as referenced in Reason #6. In fact, getting a big mortgage and using investment proceeds to help you make the payment is superior to getting a small mortgage and having no proceeds to invest.
TOTALLY AGREE: This is even more powerful a concept. Make the one time decision to invest and use that investment to pay the house payment (cash flow) that you don't like. Let's say you put the $240,000 investment at closing, and withdrew $1,011 to make the full payment for 30 years. Your payment out of pocket is $0, but after 30 years there is still a balance of $1,185,097.77. How would that help in retirement? The house cost $300,000 and you are illustrating an example of savings that is almost 4X the price of the house.
Source: $1,011 per month DEDUCTED for 30 years after lump sum $240,000 investment at 8% after tax
TIP: When you learn to express the value of your advice, and focus on the problems you solve your value to the client goes up exponentially. The advisor partner here wins as a change to help the client better create wealth, and a Realtor will get to sell bigger properties in the future as the client is wealthier.