I was just thinking about how long I’ve lived in my current home. Seven years. It’s gone by pretty fast. And as our lives have improved, my husband and I both advancing in our careers and getting higher paying jobs, we have stayed put in our “starter home”. And we have bought a few rentals in that time period. We’ve made investments and achieved quite a bit. It has been tempting to find another place in town; a bigger McMansion on the “good” side of town, but we so far we have just stayed. But I wonder, how great would it be if by now our house were paid off!? How many more fruitful things could we be doing with that extra money? I would love to have a mortgage burning party! It would signal that I have been freed from this prison sentence.
So today I was thinking about what it would have been like if we had gotten a 7 year mortgage loan on our primary house instead of a 30 year. Why are 30 year home loans the standard? How many people actually pay off their homes (or even stay) in 30 years? Wouldn’t it make more sense for a home loan to be a much shorter period of say, 7-10 years? To better illustrate this, look at the difference in interest that you will pay over 30 years @ 5% interest compared to a 10 or even 7 year loan @ 5% interest on a $100,000 property:
$100,000- 30 year mortgage- 5% interest =Principal and Interest: $536/month
Total interest paid: $93,255.78! Or in other words, a $100,000 house for about $193,000.
$100,000- 10 year mortgage- 5% interest =Principal and Interest: $1060/month
Total interest paid: $27,278.62 -total about $127,000
$100,000- 7 year mortgage- 5% interest =Principal and Interest: $1413/month
Total interest paid: $18,724.84 -total about $119,000.
(Figures calculated at Bankrate)
So, let’s look at that objectively. The monthly payment is much higher for the 7 year loan than the other two. In fact, it is nearly 3 times as high (2.6) as the 30 year. However, the amount of interest paid over the period of 30 years is 5 times as much as the 7 year loan! Compared to the 10 year loan it is 3.4 times as much interest and less than twice the mortgage cost per month. In other words, you could pay off your house in a 1/3 of the time (on the ten year example), but pay barely twice the cost of the mortgage payment and save about $66,000 in interest in the process.
This also doesn’t take into account that the interest rate on a shorter term loan is usually lower than a longer term loan making it even more attractive. What’s more, is that since most people don’t last the full 30 years, they take out second mortgages, refi (usually to another 30 year loan!) or otherwise prevent themselves from owning it outright.
People need to remember on any loan that is amortized, the first payments pay virtually nothing toward the principal and the last few payments pay almost everything towards the principal. For a longer term loan, it is much harder to pay down the principal. Which speaks to another reason for our housing bubble crisis. When we had such low interest rates (as we still do), the policies should have encouraged people to get the shortest term loan possible and the goal in the end should be to have as many people as possible in houses free and clear!
Imagine what a different society we would have if half the population (or more!) owned their own homes outright! Wouldn’t that change things? Especially when housing costs are almost always the highest costs for people. If we could get people out of the cycle of debt and more debt on top of old debt and instead move people (with our policies) toward a debt-free lifestyle I think we could eliminate many of society’s ills.
The argument would be that this might push people who otherwise could barely afford a house with a 30 year loan out of the running for the “American Dream” of home-ownership. Well, if they can barely afford it with a 30 year loan, it might not be the right time to buy a home. This is similar to the argument of why people shouldn’t have to put down the 5 or 10% down payment. If they can’t come up with at least that much, they have no business in getting into bigger debt on a house! This is kind of like a test to prove that you are serious and stable. If not, you should wait until you can. Simply put, not everyone is prepared to get into this type of debt obligation.
A house is an expensive, ongoing cost that pretty much mandates the ability to save. Maybe they need to learn the ABC’s of financial literacy first before jumping in to home ownership. A requirement to put money down is a good practice because it makes people remember that they have a piece of skin in the game; that they really want this and aren’t just going along with it because everyone else is. They would be much less likely to default on the loan if they had a lot of their personal hard-earned money on the line. People would also be more likely to buy a house that is truly within their price range instead of stretching to get the biggest, fanciest thing possible to “keep up with the Joneses”.
In fact, I would say decreasing the standard mortgage term from say 30 to 10 or 15 would actually help people out a lot. The current 30 year loan standard is much more unfair. It takes so long to get out of debt that it feels you never will. After 7 years on a 30 year $100,000 loan, guess how much you still owe?! $87,774.63! You have barely made a dent. And after 10 years? $83,276.42
If you could see your loan coming up to its end in a decade or less (year 7 on a 10 year loan $100k loan you only owe $34,476.30 compared with year 7 on a 30 year with $87,774 remaining) with huge amounts of your payments going to the principal, wouldn’t that give you motivation to finish it off and pay it? I mean, really, would we want people with 50 year loans because we could barely scrape them into qualifying? Isn’t that taking advantage of the system and the most vulnerable people? If we start to look at 30 year loans that way then we can see that they are really taking advantage of people like a wolf with sheep’s clothing.
The reason it looks like a sheep (ie a good thing) is because it seems like you are doing the responsible thing…you are keeping your payments low in order to be sure that you can pay them. But really, for all the reasons I listed above, you are probably doing yourself -and in turn, society- a disservice. Because of your fear, you have created a monstrous beast called endless (or at least 30-year) debt.
Remember that the word mortgage and amortization have in their etymology the latin word “mortus” which means “death”. So, break free of them (and let them die!) as soon as possible and go live fruitfully!
From what I have read and witnessed, most Americans only consider the monthly payments when they make a purchase (house, car, appliances). They focus on the ‘low’ monthl;y payment that marketers place in advertising and the rest is forgotten. Hard to believe but true.
I have had 4 homes, and only had 1 mortgage (15 year) on the first house. This was paid off in 6 years, no early prepayment penalty. From 100% ownership standpoint I can say that it is a good feeling to own, but scary too. If the market drops 50%, like it has in some areas, I will loose 50% of my money. For those who own 10% of their home, they can, and do, walk away, losing almost nothing. This is going on all over the country. And when they walk away, the neighbors house values drop. Bankruptcy allows this cycle to continue. Other than saving $$ on interest, there is little reward for 100% ownership.
I always hope that we will be able to pay our mortgage off early. Conventional financial wisdom argues against this plan. . .my mom, as a financial planner, always says that your home is a “dead asset” because of the possibility of market fluctuations and such.
But I really disagree with that idea. Here’s what I have seen in my adult life. . .first, the “tech bubble” burst, and people lost their entire life savings when those stocks tanked and couldn’t retire. And then, the economy tanked and the value of everyone’s stocks and investments dropped and people couldn’t retire. In my mind, once you own your own house, you at least have something real in your portfolio that you are in control of. In the end, I think even if the sale value of the house you own is less than you paid for it, at least you have a place to live, maybe grow some food. . .which to me seems like something more real and beneficial than stocks and bonds. And that is really important to me.
That’s a good point, Wil. Which is why I think this should speak to the larger issue at hand which is encouraging people to own things (not just houses) outright and keep debt to short-term easily paid-off periods. Any time a society is based in large part on “margin” or future money, it does not exist in the current state. Therefore, it can crumble at any time, creating DISincentives for people who do the “right” thing, like owning it outright.
If our standard for mortgage length was 10 or 15 years instead of 30 and people truly had to qualify for them including with a down payment, we would have fewer foreclosures and the problem that you mentioned (declining neighborhood values) would be essentially non-existent. Although it is possible that if more people owned their homes outright there may be fewer sales, with fewer people trying to make a quick buck and that might moderate prices somewhat. But is that such a bad thing?
Good job on owning your homes outright! Everyone needs somewhere to sleep so even if the “market” around it is crashing, you know that someone can’t take that away from you. I understand the power of leverage and of spreading out your risk (10% in something instead of 100%), but when it comes to your primary home, little else could provide the security of knowing your home is YOURS and not the bank’s. A home is a building, not some abstract idea (like a stock). It is there in clear tangible form.
A paid-for home with some land to grow and make things and you are even closer to getting off the crazy rat race cycle we have created in America (and other industrialzed countries).
Claire,
I must have been writing my response to Wil right as you were typing your comment! As you can see, I totally agree!
Hi Cassi,
I have to disagree with some of your statements about the cost of a loan!!! I do agree with what you say about people getting to big of a house or loans they shouldn’t get. It’s funny though that you and Katrina think the same way.
Today you can get a 15 year loan for 4.3% or 30 for 4.9%!
4.3% mortgage loan is a great deal. First, all the interest you pay is tax deductable. Say you pay $5K in interest per year, if you’re in the 25% tax bracket you “save” – (reduce the cost of the loan) by $1250.
This “savings” reduces the cost of the loan. Just guessing here but if your interest rate is reduced by a 25% tax deduction your interest rate would effectively be a little more than 3%
Then you need to factor in the worth of today’s money vs tomorrows money. $1 today is worth a lot more than $1 in 30 years. I would guess $1 today would be worth $3 in thirty years.
So that lowers your interest rate even more. Probably less than 3%. You can get a 10year CD @ 3.35 right now (reduce it by the taxes you pay on the earning and maybe it becomes 2.5%) You could probably get a much better rate. I just did a very quick search on Schwab. More likely you will earn a very safe 6%.
People who get these low rate loans won’t want to sell their house and give up the loan because its such a good deal now.
Technically it make more financial sense to take a 30 year loan at less than 5% then to pay for your house up front. It all depends on your level of discipline.
You are right on about the real cost of a mortgage (goes for car loans, too, which are used for over 95% of new car purchases).
However, with the way the U.S. government and financial institutions corrupted the home finance business with lax loan standards and too much money floating around, values of homes were artificially inflated, sending the values temporarily upward, creating a few winners and many losers, and hurting some owners who have real skin in the game and need to sell during the downturn.
Since you paid modestly for your investments, and they are maintaining value, it is still wise to invest in them and pay down the mortgages, as you have pointed out in your post. Money in a CD nowadays only brings 1 to 3 percent at most, while even a modest mortgage rate is 4 – 5%
Our five properties are debt free, most purchased cheaply and 4 of them bring in a good rental return (approximately 6 – 8%) on investment. The upkeep and taxes are a good tax shelter, although it still is a business and work. The long term benefits for this money management are: freedom from the mortgage cost itself which you mentioned, investment in a basic need (housing) which in good times inflates, and in bad times brings more rental customers and income. No banker or investment company has their hands on and in to your dough, and you know what is going on with the value and return because you own it.
The popular culture is as you mentioned, “Keeping up with the Joneses” —- overextending, and not sacrificing to save, so a paradigm changes in values would have to occur before folks settled down to modest lifestyles and responsible financial management again. This modesty would extend into food production/consumption, energy use and carbon emission, child care, education, labor practices, transportation, health and fitness and almost every aspect of our lives and would be directly contrary to what the corporacacy wants (you have blogged on much of this already on this site). The more we spend and consume the more they make (our bad).
Capitalism at its best for the middle class is modest investment and hard work, although one needs to be savvy about when and where to invest and have the patience to let the investments mature. It is not a controlled casino like the stock market or a low return and energy bank account. Takes guts, hard work and insight.
Jeff,
I understand that these are all the numbers that we’ve been given when we are talking about a loan, but the true story behind these numbers is what matters. When you amortize something, you pay WAY more than the 4 or 3% interest on the loan in interest in the first few years (which is all most people stay in a house for). Let’s say in the example I gave above with the 30 year mortgage. Your payment is about $537 (P+I) but for the first year you will pay about $415 in interest! That’s about 77% interest for the first year. The last year of your loan is the opposite, but who waits that long? And how many people are encouraged to refi for the same reasons you mentioned! As for a tax benefit, that’s nice that they allow you to write that off your taxable income, but I think I’d rather not pay it in the first place!
Consider the example of the 10 year loan. The mortgage amount is $1060, but in the first year you will be paying around $650/month to PRINCIPAL! “Only” 39% interest rate that first year compared to 77% on the 30 year. If we were to amortize a loan with equal amounts of principal and interest across the entire loan period that would also help people to pay it down more quickly and own it outright.
For most people, long-term 30 year mortgages on their primary home is not a good idea, they are paying way too much money without anything tangible in the end (which is not usually 30 years!). That is why I wrote the post about the primary home not being an investment. But rather we need to make sure it is not a liability (an ongoing subscription) and make it a one-time necessary purchase.
Annie,
You are such an inspiration to us. It does take a lot of work, mostly mental power. With rentals or business deals, I can see the benefit of some mortgages or longer term loans because you are able to leverage your money to make more deals without tying it up (and the rent can usually cover the mortgage costs). Nevertheless it is great to own them outright! So far we only have one like that, but we love the feeling.
Unlike my spouse I think we’d be better off buying only what we have cash for. Puerto Rico is kind of like that…lab tests, doctor visits, restaurants, car fix-it places and a lot of other places operate with cash only. I used to believe in Darwin’s survival-of-the-fittest and thought I would be one of the survivors…then I believed reverse Darwinism…now I believe reverse Darwinism is true Darwinism. The survivors are the people with huge debt, who have loads of kids, live off the system (take bailouts, get rewarded for bad behavior), don’t care about ecology (are consumers), don’t have to work for anything (live off the system or steal), and don’t worry about stuff. Why even file taxes? Sell crap in the street and don’t claim income. Yes Darwinism at its finest. I wish we lived in a hunting gathering time or at least that the money I’ve got was in a sock and not a stupid fictitious IRA that I will never live to collect or when I do the value will be less than what I contributed…just some thoughts.