Carrying mortgage debt vs. paying off mortgage

[sofocused978]

So I have a couple questions concerning mortgages and carrying a note instead of paying it off with the quickness/buying a home outright. I keep reading online where someone asks about just saving up and purchasing a home outright or starting to hammer away at the balance of their mortgage and get it paid off fast where people are advising it's a bad idea due to "tax advantages" yet nobody seems to put the numbers out their to prove their point. So I figured I may be able to get a good answer from the people on this forum.

What makes it so smart to carry a large amount of mortgage debt @ say 5-6% interest for decades instead of getting it paid off as fast as you can or putting up bunch of capitol and buying the home outright and minimizing or not pay any interest at all? If somebody could show some #'s too that would be awesome.

[LivingAlmostLarge]

Well first off how many years would it take to save up $575k to buy my home? This is on top of paying minimally $2k/month rent. So I'd need assuming $1k/month savings that's 575 months which is around 60 years. Plus the price will be rising as I save $1k/month, so how many more years will it take for me to save up cash to buy my home?

The problem is that renting is not cheap where I live, nor is buying a home. Thus I am guessing that in order to save the cash up, it would take longer than the interest on a mortgage. after all I would be paying out already $3k/month between rent and "Savings" for a home.

Second, hammering away the mortgage. Why not? I have a lot of other bills I need to save for. So it's just not possible right now. I need a new car one day or newer used car. I need to save for home repairs, replacements, college, etc. So I guess ideally I'd be able to save for everything and pay off a mortgage fast. But like above, there is only so much money to allocate and there are other needs.

[jIM_Ohio]

First- if mortgage rate is 5%, most people can invest in stocks and bonds and get a 5% average return... 8-9% returns are not uncommon. This has nothing to do with taxes, that is leverage (borrow money at low rate and invest money at a higher rate).

Second, my situation is a good tax example. I am doing taxes now (taking a break), but here is typical situation:

1) Gross income is 130k, married filing jointly. This starts us in the 25% tax bracket. (Tax owed would be 24862). We pay about $40,000 in mortgage interest per year. With some other deductions that 130k is lowered to about 65k per year. 65k is in the 15% tax bracket (tax owed is $8912).

So I pay $40,000 in mortgage interest to save $16,000 in taxes
These are the types of numbers you will see. I prefer to have a house which raises my net worth than pay taxes which lowers my net worth.

Make sense?

Do not get a house just for the tax break, but if you have one, it will lower your taxes and make your money work "efficiently" relative to renting.

[MonkeyMama]

Actually, keeping a mortgage for the tax break (alone) rarely makes any sense. You pay x to save a mere fraction of x. Clearly people don't pay a mortgage for the tax savings. It would cost far less to have a paid off mortgage.

In general, tax breaks change the playing field between renting and owning. It can be an enticement to own over renting, etc. But, that being said, the average homeowner does not get any tax benefit from owning a home (or nothing to write home about). Also, the later you get into a loan, the less interest you are paying, and the lower the tax break gets. So it certainly is never a reason to KEEP a mortgage, forever.

Basically, keeping a mortgage for "tax advantages" is not really much of a valid argument, for the AVERAGE homeowner.

However, there are many other reasons to keep a mortgage. Leverage being number one. Leverage works well with a low fixed rate mortgage. You borrow 30 years on a mortgage, and have a low enough payment that you can save for a rainy day and contribute large amounts to retirement, etc., etc. In general, a longer term mortgage will free up more of today's dollars. Early in the loan you are mostly paying interest and you will get a higher tax deduction. With time, your mortgage payment will not go up, but your income and the cost of everything else will go up. Tough you may be stretching for your mortgage in the beginning, it will become easier to pay with time. You are also mostly paying principal on the back end.

Often, in the "prepay vs. invest" debate, not a lot of validity is given to inflation and the time value of money. There will always be people who say, "I don't know any rich people with a mortgage." In reality, I know a lot of wealthy people, and am from a wealthy region. Most of them had a mortgage, couldn't have imagined pre-paying a dime years 1-10 (before being wealthy) because money was so tight, and then were able to easily pay off with increased income, years 15-20. The thing is, they were investing all along, always had a strong cash position, and will come out ahead, asset-wise, than most people who paid off their house before saving for a rainy day or investing.

However, my experience is extremely high cost of living area. (& high wages go along with that). I think it is possible for many to balance the 2 - save a decent amount for retirement and a rainy day - and pay the mortgage off a little more rapidly. But the most financially efficient strategy is really going to vary by each individual's situation.

I personally run rather squarely in the middle. We put 25% down on our home, and wouldn't borrow a dime against our home - for anything. We also do not prepay a dime, considering our current income. We have a 30-year mortgage. However, I would consider putting 100% of my spouse's income to our mortgage, to knock it out in a few years. I expect our mortgage will be paid off in our 40s. Even living in a high cost area. Which pretty much means I don't identify with either side of the debate - middle of the road is win-win.

[sofocused978]

So I pay $40,000 in mortgage interest to save $16,000 in taxes

Make sense?

For some reason this really doesn't seem to make any logical sense to me lol.

Thanks for the explanations and somewhat bringing me up to speed everyone.

[jIM_Ohio]

For some reason this really doesn't seem to make any logical sense to me lol.

Thanks for the explanations and somewhat bringing me up to speed everyone.

I have the mortgage, and it lowers my taxes- I don't have it to lower my taxes (I have a mortgage so I can live in my house). But if I am getting a tax break, I am going to take it.

As others said, don't get a house to save on taxes, but once you get one, you will save on taxes probably.

[Caoineag]

Basically its an opportunity cost. You only have so much money so how are you going to use it. I have never seen the point of a large mortgage over decades but I got a cheap house with a 15 year mortgage. I receive no deductions because I don't pay enough in interest. At my loan size, the difference between a 15 and a 30 year are small with the 15 year being cheaper in interest so it doesn't cost me much to "prepay".

That said, I will be maxing out my retirement savings, paying off more expensive debt and saving enough for short term goals before I prepay anymore.

[Mike75]

I always recommend people to spend in the limits of their pocket. If you buy a house, will you be able to sustain the mortgage repayments. Plus, you will also have the expense of maintaining the house and higher taxes.

If you think you can afford all this right now, only then purchase a house.

[LivingAlmostLarge]

MM You hit it on the head. These first 10 years it's hard for us to prepay our mortgage. But I am guessing if we stayed put we'd be able to easily manage later.

But for now we have a lot of other savings goals. We keep a mortgage not because of the tax break, but because we just can't afford a home without it.

[ea1776]

For some reason this really doesn't seem to make any logical sense to me lol.

Thanks for the explanations and somewhat bringing me up to speed everyone.

The example doesn't factor in the EQUITY you are building in the house. For all of the principal you put into the house, you are taking more and more ownership of the house. When you rent, you are never buying any ownership in the house.

Also, you have to think about housing appreciation. How much can you reasonably expect the house to go up in price over the long haul ?

IMHO, buying only makes sense if you have at least a 25% down payment, a 6-month emergency fund, and another tidy bundle saved away for repairs and other home-owner expenses. Oh, and I would also say don't buy if you have CC debt or other "over-spending" type of debts.

Try searching on youtube for "buy vs. rent" videos. There are a ton of great examples that will show you the numbers.

[bdizzle]

The example doesn't factor in the EQUITY you are building in the house. For all of the principal you put into the house, you are taking more and more ownership of the house. When you rent, you are never buying any ownership in the house.

Also, you have to think about housing appreciation. How much can you reasonably expect the house to go up in price over the long haul ?

IMHO, buying only makes sense if you have at least a 25% down payment, a 6-month emergency fund, and another tidy bundle saved away for repairs and other home-owner expenses. Oh, and I would also say don't buy if you have CC debt or other "over-spending" type of debts.

Try searching on youtube for "buy vs. rent" videos. There are a ton of great examples that will show you the numbers.

I don't really think he's talking about renting at all. He's saying if he has, say 250k in cash, should he just buy the house outright, or get a mortgage. The only thing I've ever heard that make sense as to why you should get a mortgage vs paying in full is the interest you'd make on the money. Put 50k down on the property, and invest the 200k in the market, for example. You'd be netting a +5% return on your money.

[bjl584]

There's nothing wrong with mortgage debt as long as it's manageable. As others have said don't get a mortgage just to save on taxes, but if you do have a mortgage the tax break is available to you, so take it. Mortgage rates are low, so most people can get a better return on their money by keeping the loan and investing their money elsewhere. Of course, in this economy the possibility of a job loss is a real factor. In that case, I would much rather be in my house free and clear and not have a monthly mortgage payment hanging over my head while I was unemployed.