Your Key West Florida Keys Real Estate Property Specialist Gloria Sellers, GRI
A Mortgage as an Investment
Most people have heard that ``owning a home is investing in your future''
or ``mortgage payments are a forced savings plan.'' In fact, owning a home presents
a great opportunity to individuals to manage their debts like they manage other
investments. However, owning a home involves more than simply taking a 30 year
fixed rate loan and then sitting back waiting for market appreciation as you
pay down your loan balance. Managing your debt like you manage your stock portfolio
can save you thousands of dollars over the life of your mortgage.
Most people strongly believe that in building wealth and maximizing net
worth, debts are as important as assets. For most of us, the biggest
portion of debt on our personal balance sheet is our home mortgage. To
wisely manage this debt, we should monitor our loans closely to minimize
interest costs and maximize our net worth.
Reducing 1% off of interest costs on your loan is equivalent to
increasing your investment returns from 9% to 10% in a year. You can double
that savings if your loan is twice as large as your investment portfolio,
which is fairly common in these modern times.
To analyze your mortgage like an investment consider the
following:
- The Hold Period, i.e. how long you plan to be in the home or with the
loan
- Your Future Interest Rate Assumptions
- Interest Costs vs. Nominal Payments
- Present Value vs. the Future Value of Money
- Tax Deductibility
- Return on Other Investments
Hold Period
With all the new loan products available, one of the most important factors
in deciding which loan product to choose is your hold period. Even a one year
change in how long you plan to be in the home or with the loan can cause a dramatic
shift in the overall analysis. Match as closely as you can your expected stay
with the fixed period that you select for your loan. This is particularly easy
with today's hybrid loans that give you choices of 3, 5, 7, and 10 year fixed
rates then converting to Adjustable Rate Mortgages (ARMs). All of these loans
are still amortized over 30 years so you needn't worry that the payments will
be higher than a standard 30 year fixed loan.
The longer the fixed rate term on your loan, the higher the interest
rate will be. A 5 year fixed to ARM will have a lower initial start rate
than a 30 year fixed rate loan. If you only plan to own your home for 3
to 5 years, then there is no reason to pay the higher interest rates of
a 30 year loan.
A useful question to consider is the following. Would you invest $200,000
in a 30-year fixed asset and never monitor the market again? Then why do
many people start their search for a loan by deciding that a 30-year fixed rate
is the best product for them? In fact, most people overpay on their mortgage
interest by staying with a longer fixed period than is appropriate for their
situation.
Why not consider a shorter fixed length and focus more attention on your
single largest asset, your home. By devoting a small amount of time to
managing your home mortgage, the benefits can outweigh the time invested.
Today's refinance process is becoming simpler and the process of securing the
right loan has never been easier with the advent of Internet mortgage services.
Easier access to information and services, combined with the forecast by many
for steady to declining long-term interest rates, translates to a variety of
shorter fixed-term products that will save you substantial interest costs over
time.
Future Interest Rate Assumption
Your personal expectation for the future of interest rates is an
important factor to consider when choosing a mortgage loan. If you feel
that interest rates are going to skyrocket, then you'd certainly want some
sort of fixed rate. If you believe that interest rates will remain
relatively stable, the savings of an Adjustable Rate Mortgage (ARM) might
be more attractive.
Uncertainty about interest rates causes borrowers to make decisions
along risk comfort levels. Only you can decide which loan ``feels good''
and you should not let a broker or agent dissuade you from what is most
comfortable for your risk profile.
Interest Cost Versus Nominal Payments
Monthly (nominal) mortgage payments include an interest payment and a payment
toward the reduction of the loan's principal balance. Any loan analysis that
simply adds up payments will become increasingly skewed over time due to this
principal reduction. As an example, a 15-year fixed-rate loan may have a higher
monthly payment since you are paying off the loan over a shorter period of time.
However, the loan's total interest costs may be substantially lower.
Some products, such as ARMs tied to the 11th District Cost of Funds, offer
the option of paying a lower payment and sometimes have payments that are capped
from one year to the next. While this type of loan appears to have the lowest
payment, in fact the principal balance can actually increase over time. This
occurs when the cap placed on the annual payment increase results in a monthly
payment that does not cover the true interest costs that you have on your loan.
This is an example of what is called "negative amortization," which
means that your loan balance can increase instead of decreasing over the years.
While this type of loan may sound dangerous, it can in fact be used
wisely. If you temporarily have a reduction in income, possibly a spouse is
home with a child or temporarily out of work, then consider how a payment
capped loan can work in your best interest. It allows you to use the equity
in your home instead of taking cash from your income or savings.
Although it's a little more difficult, the interest costs rather than
the nominal payment need to be calculated for a true mortgage loan
analysis. Use an amortization calculator or schedule to determine the
interest costs over the hold period for the loans you are considering.
Present Value Assumption
If you had the choice of receiving a dollar today or a dollar in 30
years, you would probably take the $1 today. In other words, a dollar paid
in 30 years is clearly worth less than a dollar paid today. When comparing
various mortgage payments on different loan options, it isn't enough to
simply add up all the payments over the total number of years. If you did
use a simple addition formula, and then compared two different payment
totals, you would be ignoring when the payments are being made on the
different loans. By doing so, you would probably be lead to the wrong
conclusion. A discounted present value analysis, while it may sound complex, simply
allows you to add up all the payments of two totally different loan
products with different payment schedules while considering the time value
of money. Tax Advantages
An additional factor to consider when viewing your mortgage like an
investment is the tax advantage of mortgage debt. Because a portion of your
mortgage payment is deductible for income tax purposes, this should be
taken into account when comparing disparate payment options. Mortgage
interest along with the points (origination fees) paid up front to secure a
loan are deductible items for taxes. Points are treated differently in a
refinance versus a purchase loan. In a purchase transaction, the points can
be deducted in the year that they are paid. In a refinance, they must be
amortized (paid off in increments) over the remaining life of the loan.
Once the borrower refinances, they can deduct the balance of the points
from the previous loan at that time. (This is a somewhat simple summary,
and we recommend you use a tax advisor for a more robust description.)
Return on Other Investments
Finally, in analyzing your mortgage, don't ignore the opportunity costs of
not having cash in your other investments. If you are able to invest your cash
in ways that produce higher returns than your interest expense of your mortgage,
it may make sense to take a shorter fixed loan and invest rather than paying
more on a 30-year fixed mortgage.
One web based mortgage source called E-Loan can analyze a borrower's
information to recommend mortgage loans based on the above criteria. This
is an easy way to keep your mortgage choice consistent with your other
investment decisions. Some of the above factors like interest costs,
present value assumptions, and tax deductibility are built into the
program. Other factors are determined by user input.
Please click here for that program.
In summary, it pays to monitor your loan and treat it as seriously as you do
your assets. Since most people have mortgage balances that are substantially
greater than their portfolio of assets, the limited time spent doing so will
reap major benefits. Times have changed and the choices for mortgage loans have
grown so there's probably a product available that you never even considered.
Copyright © 1997 E-Loan Inc.
540 University Avenue, Palo Alto, CA 94301
All Rights Reserved
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