Thread by @roncaruthers

1. Thread: Which mortgage is the 'best' according to math, science and financial planning principles?

Go get some coffee, kids. ☕️

We're going to be here awhile.

But when we're done, you're going to know more about mortgages than the banks do.

Ready?

Let's go:

2. First, A quiz to test your mortgage IQ.

True or False?

-You are safer having your mortgage paid off than owing 100%

-A large down payment saves you money vs. a small down payment.

-Paying extra saves you money because your house is paid off faster.

3. Mortgage True or False quiz PT 2:

-A 15 year mortgage saves you more money over time than a 30 year mortgage.

-And finally, the interest is the main factor in determining the cost of a mortgage.

Make a note of your answers, because we'll come back and revisit these later.

4. The reason that understanding this is because your housing decisions are your biggest cash outflow each month besides taxes.

And you will spend more money here than pretty much anywhere else, because sleeping indoors gets expensive.

5. And banks love making this complicated with so many mortgage options available.

Now, before we get into the actual math, let's look at some basic info.

6. First, you have to understand opportunity cost.

All that simply states is that if you spend a dollar on anything... taxes, mortgage, food...you don't just spend that dollar....you 'spend' everything that dollar would have made if you hadn't spent it.

7. Replace the word 'spend' above with 'lose', and the concept will make more sense.

The 2nd concept to understand is the concept of Wealth Transfers.

A wealth transfer is going to occur no matter how you pay for your house.

If you finance it, you pay interest.

8. Everyone gets that concept.

But...

If you pay cash, you LOSE the interest that you would have made if you kept the cash.

So the wealth transfer happens regardless.

The question is what is best for your situation.

And everyone's situation is different, but some rules apply

9. 3rd concept:

I believe that you need to pay attention to the liquidity, use and control of your money.

YOU want to be in control of it and have access to it.

When people get into financial trouble, not having access to their money is almost always the cause.

10. Did you know...

-About one third of the houses in America are paid off?

For the rest that aren't, there are usually 3 financial reasons why people have a mortgage:

-They can't afford to pay cash;

-They want the tax deductions that a mortgage provides;

11.

-They benefit from the spread.

Meaning, they may have the money to pay it off, but they're making more money on their stuff than the mortgage is charging them, so they don't want to interrupt that cash flow.

Basically, Rich Dad 101 stuff.

12. OK, so with those basics out of the way, let's get to the math.

First, I have spoken extensively before and recently about the effects of inflation on your long term wealth,

BUT...

Your mortgage is the ONE place where this works in your favor.

13. Check it out:

If your mortgage is $2,000 today, in 10 years, that mortgage payment will still be $2,000.

But, if inflation is 3%, it's going to FEEL like $1,488.

Because in 10 years, $2,000 will only have the buying power of $1,488.

14. In 20 years, that payment is going to feel like $1,107.

And in 30, it's going to feel like $824.

Having a hard time with this concept?

Ok, think back to what the cheapest you can ever remember gas being.

How would you like to lock in THAT price for gas forever?

15. When you take a long term mortgage, that is exactly what you're doing.

You're locking in your payment in today's dollars.

So, if a dollar today is the most valuable it will ever be, and be worth less each and every day

Why would you hurry to give those dollars to the bank?

16. It doesn't make sense, does it?

OK, so inflation is one key factor in determining whether you should have a long or a short mortgage.

Next, let's look at your down payment, and whether it should be bigger or smaller

17. But first, a couple of questions:

-Does your down payment earn interest?

-Can you access it easily?

The answer to both of those is 'no'.

And, whatever your down payment could have earned is the opportunity cost.

18. So, let's look at the biggest down payment you could make: All of it.

In other words, paying cash for your house.

So, let's say you bought a house in Texas 20 years ago for $400,000.

And you *could* have safely earned 6% on the money if you hadn't put it on the house.

19. If you cannot sell that house today for 1,324,000 after real estate commissions,

You made a *minor* financial mistake.

The Federal Housing and Finance Administration says that houses bought back then in TX sell for about $850,000 after commissions.

20. So that one decision would have cost you almost half a million dollars!

Now, if y'all want to argue about the earning 6%, c'mon man.

It's over a 20 year period. I do it safely for my clients all the time.

If we went with @DaveRamsey 's 12%, you cost yourself 3.5 million.

21. But is your house a good place to park your money?

Well, let's go back to our Texas example.

If you sold it for a net $850,000 after 20 years, and paid $400,000 for it, what was your rate of return?

Did you say 3.84%?

That's almost right.

But, did you improve the house?

22. We have to put that cost in for that, as well as any repairs.

So, let's say $50,000. Over 20 years, I would argue that that is very low.

What about taxes and insurance?

Let's assume 1% a year (which I think is low for Texas).

So, you've paid another $80,000.

23. Once you factor those in, you really made 2.39% on your house.

Do houses ever go down in value?

Absolutely. Remember 2008?

So, even that 2.39% isn't guaranteed.

Does this mean you should never pay cash?

It just says your house isn't where you want to keep your money.

24. Now, before we look at the math of a 15 year vs. a 30 year mortgage, let's recap.

25. Why do most people choose a 15 year mortgage?

The money they think they will save.

The theory is that a shorter loan saves you money.

But if that was really the case, then the best way to pay for your house would be paying cash, right?

And we just saw that it wasn't.

26. One of the main things I hear is that 'I'll really start to save once my house is paid off!'

Or, 'I just want to get that monkey off my back'.

Let's look at the math behind that.

27. If we take 2 mortgages at 4% each, a 15 and a 30 year on our $400,000 house,

The payments would be:

15 year: $2,959

30 year: $1,910.

Difference: $1,049.

28.

So, what happens if we start saving the difference of the 2 mortgages right away, vs putting the whole thing away once the 15 year mortgage is paid off?

At 4%, the numbers are the exact same:

After 30 years, you have $728,121 in EACH account.

BUT......

29. If you earn 6% on the accounts,

on the 15 year mortgage where you save the entire payment after it's paid off, you have $860,460.

On the 30 year mortgage, you have....wait for it....

....$1,053,827.

Almost a $200,000 difference on the EXACT. SAME. DOLLARS.

30. Back to Dave Ramsey, if you earned 12%, the difference between the accounts is now over $2,000,000.

It's 2 million MORE in the account where you took the longer mortgage, and invested the difference right away.

31. Now, it's not ME saying you're gonna earn 12%, but he's the guy saying you should rush to pay off your house, and all I"M saying is if you believe what he tells you, then you have to admit, he's lying to you.

If you're really earning 12%, why would you EVER rush to pay off?

32. OK, now, watch THIS:

Let's take our 15 vs 30 year mortage, AND we'll even lower the interest rate on the 15 year by 1/4 %, just like the banks do.

Why do they do that, btw?

Because it's bait for YOU.

Cause they know what YOU didn't: That dollars today are more valuable.

33. Now, back to our example:

Here's the question, even with the lower interest rate on the 15 year mortgage, the difference between the 2 mortgages is $999 a month.

What interest rate would have to earn on that $999 if you wanted to save it and pay your house off in 15 years?

34. The answer is 3.19%.

If you earn 3.19% or more, you are guaranteed to have enough money to pay off your house in 15 years (or less)

AND, YOU retain control of that money right up until you write that check.

Now, what if you earned 6% on that side fund?

35. When would your house be paid off?

13 years and 7 months.

Same exact dollars.

YOU retained control of the money.

AND, you got your house paid off even faster than you would have just taking the 15 year,

saving yourself 17 payments of $2,908 for a total of $49,436.

36. Remember opportunity cost?

If we just took those 17 payments and invested them at 6% for 20 years, it would grow to $158,547.

36. One last point on this.

Assuming you ARE in a position to itemize your deductions, you would have $60,573 in tax deductions in the first 15 years of a 30 year mortgage at a 30% tax rate,

vs $37,080 for the 15 year mortgage.

Another $23,000 saved.

37. So.....what have we learned here?

We'll recap in a few minutes.

38.

OK, let's go back to the quiz:

Do you save money having a 15 year mortgage over a 30 year?

No. And, you lock yourself into a higher payment.

If you lose your job, and you have a 15 year mortgage and/or you've been sending them all of your extra money to 'pay it down' fast

39. Like a certain grumpy radio host tells you too, is the bank going to help you out and give you that money back?

Hell no! Why? Because the mortgage isn't a loan on your house, it's a loan against your income. And you ain't got none now.

40. Same if you get disabled, btw.

Do you 'save' money by having a larger down payment?

Nope.

41. Are you 'safer' having your house paid off?

Well, this could go either way.

But, I know plenty of people who lost their homes in Katrina that would say 'no'.

If you own your house cash, and disaster strikes, YOU get to fight the insurance company.

42. If you have a 100% loan on your house, and disaster strikes, the bank and the insurance company can fight each other.

Better yet, if your money is liquid, you can go get another house while they duke it out.

43. Is the interest rate THE most important factor in the cost of a mortgage?

No. LOTS of other factors come into play.

Now, that doesn't mean it ISN'T important, just not the MOST important.

44. So, what have we learned today, kids?

As a general rule: put the least amount down on your house they'll let you, and take the longest mortgage they'll give you.

And be SMART and save the difference.

/End....for now, at least.