THE TAX ATTIC — by Roger Allen, publisher

New look at home mortgages

Jerry Coon

I went to a seminar recently that forced me to think outside of my financial box, so to speak. I’m from West Michigan, so my financial box is pretty conservative.

Dave Ramsey isn’t my idol—that spot is and always will be reserved for the Detroit Tiger’s great player, Al Kaline—but I do appreciate and agree with most of what he says. Dave isn’t from West Michigan, but he could be. When I say his financial box is very conservative, I might actually be understating his stance.

What shook up my box concerned the speaker’s treatment of home mortgages. Dave says to get rid of the darned things as soon as possible. It’s prudent to make the term of the loan 15 years as opposed to 30; 10 would be better. Make use of strategies such as bi-weekly payments. At the very least, pay extra on the principal each month. If you can squeeze in an extra payment once a year, do it. If you can pay cash for a house, do it quickly. For goodness sakes, the higher down payment you can make on the house, the better. Don’t pay any more interest to a financial institution than you have to.

The speaker at this seminar had a slightly different take on the subject of mortgages. In fact, he said there is no book of “Dave” in the bible, so don’t take everything Dave says as gospel. That got a few nervous laughs from the crowd, especially by those of us from West Michigan. Starting out, he said a 30-year term is not a bad thing for a mortgage. It may have a slightly higher interest rate than a 15-year term, but it has a substantially lower monthly payment. My thought was, regardless of the payment amount, how can a higher interest rate be okay? The speaker pointed out that the lower payment was the key.

We tend to dwell on the wrong part of the equation. The lower payment allows the taxpayer to set aside the difference to use how that person wants to use the money. Over time, that difference could add up to a substantial amount and could be used to buy a car or pay for a child’s education. That difference could allow the taxpayer to not have to borrow other money. Dave would like that and would call it self-funding.

With the 15-year mortgage, the higher payment to the financial institution does build up equity sooner. As we have seen in the last five years or so, however, equity can go away at the drop of a hat. It’s not a sure thing. By making that higher payment, the taxpayer was losing out on the opportunity to set aside some money for himself and that set-aside money would be a sure thing. I had to think about that one for a minute, but it was a valid point as long as the taxpayer saved that difference.

The counterpoint to this argument was that after 15 years, the mortgage is paid off and the taxpayer could save a whole ton of money because he didn’t have a mortgage at all.

Some guys have answers for everything and he made two points. First, many people periodically buy newer, bigger and more expensive houses so they never do pay off that 15-year mortgage. They just constantly have a bigger 15-year payment. Of course, they would have a bigger 30-year payment as well, but that’s a good thing because it means they could set aside more money. The difference is larger as the mortgage gets bigger.

Second, most taxpayers can’t start saving the moment their mortgage is paid off, because they have a lot of other loans, such as car loans and education loans, that also have to be paid off before the real saving can begin.

Those were certainly two valid points.

The speaker had another question to ask. When would a taxpayer ever make a large down payment on a house? His answer was a predictable, anti-Dave response: never, never, never. A taxpayer buys a home for $150,000. To get the loan, he has to put down 20% or $30,000. However, he actually has another $20,000 and could also put that down. If he does, he has more equity in the home, but that equity comes at a cost. The cost is the $20,000 is no longer under the control of the taxpayer. The financial institution controls the money. The taxpayer loses the opportunity to have that $20,000 growing at some rate. It would be under his control for self-finding purposes.

A further point to be made is that the house will increase or decrease in value at the same rate whether the taxpayer puts the additional $20,000 down or if he puts nothing down. The $20,000 is just tied up in the home and gets no real return.

In the end, the speaker made me think about a subject that I considered a black-and-white thing. Pay as much down as possible. Get the shortest loan term as possible. Make extra payments. However, going forward I will not consider this subject as quite so black-and-white. There is a lot of gray to be considered. That’s what I like about this business. It’s a continual learning process and I did learn something that day. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns
Action Tax Service in Rockford. Contact Jerry
at www.actiontaxservice.com.

 

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