5 ms·

A note on the mortgage: I understand your aversion to debt, but choosing a shorter duration mortgage can increase the probability of default, even if it shorten

A note on the mortgage: I understand your aversion to debt, but choosing a shorter duration mortgage can increase the probability of default, even if it shortens the time to the point that you are debt free, because for any given amount of cash reserves you have it shortens the runway you have if you lose your income. As long as mortgage money is cheap, the most profitable course of action is to use the 30 year mortgage, but keep a large chunk of money in reserve and invest the rest in the market for the long term. And never allow yourself to not be well-cushioned. Debt gets people in trouble when they use it to get things that put them on the edge, where losing a job causes them to miss a payment. For people who stay far away from the edge, and are good with money, it's very profitable.

BuckRogers 5y ago
I haven't done it for a while but when I last compared 15 to 30 year rates the interest was outrageous, pure usury, for the 30 year. But that isn't my main motivation to sticking to a 15 year, it's just a mechanism to limit how much I can borrow and spend. It caps me at a reasonable amount without me having to think about it, while granting a lower interest rate. It just nicely lines up with an amount that my spouse or I can afford with even one job, or a very basic low paying job. I'm definitely doing what you're suggesting and staying away from the edge.
- mediaman 5y ago
  True, with a 30 year it looks like you're paying a lot of interest, and in nominal terms (i.e., the total amount during the loan), you are. But consider a thought experiment where you could borrow $1m at a low rate of interest, suppose 3%, from a generous lender who requires no collateral and requires an amortizing repayment. You take the $1m and reserve, say, $100k in "no-touch" cash (your cushion) and invest the remainder in the market, and suppose that the market returns an average of 7% over the long run. In this scenario, you obviously pay much more interest than not taking the loan. The interest you pay is nearly $500k, which sounds like a lot - almost half the loan! Yet you make a tidy profit over 30 years: after paying back the loan, you have a portfolio worth over $4 million, plus the $100k reserve you still have. While that's just a thought experiment, the math works fairly similarly for a mortgage. So long as the market returns more (over the long term - it'll be bumpy short term) than the cost of money, you will be paid handsomely for assuming lots of long-term, fixed low-interest debt and investing the proceeds. And this leads to a second surprising conclusion: you should not pay off your mortgage. Once you've built equity, releverage the house and borrow more, so long as you take the proceeds and invest it in an instrument that will pay more than the cost of money over the long run. If interest rates rise, the math might not work. This is bad advice for some people, because a pile of savings and investments can be a tempting target to use for luxury vehicles, or boats or whatever, and that can upset the math, although eventually you make enough with it that might be OK. But for people who can live as if those investments were illiquid, it's quite a rewarding path. And for some people, the psychological value of living in a house with no mortgage exceeds whatever financial gains come from continuing to pay for a mortgage. And while there's nothing wrong with that, it does come at a stiff financial cost.
VBprogrammer 5y ago
Compound interest means that you will be paying a lot more money for the same house if you buy over 30 rather than 15 years. However, for someone disciplined, taking a 30 year mortgage and paying it off like a 15 year mortgage with significant over payments is a good strategy. It means if you need to tighten your belt you can always drop down to the normal payment for a spell without so much as having to speak to the bank. The worst option is to take the 30 year mortgage and then buy the larger house that the longer period allows you to afford.
- ajb 5y ago
  The answer to this dilemma is to have an offset mortgage. Your savings offset the amount borrowed, and you only pay interest on the difference. Once you've saved enough to cover it, you pay no interest.
  - qorrect 5y ago
    Why wouldn't you just buy the house outright at that point ?
    - lostcolony 5y ago
      Fiscal cushion. If an emergency comes up, rather than having no money to pay for it, you instead can cover it, and just pay a little extra each month going forward until you recover. That said, I don't think they exist in the US.
  - ineedasername 5y ago
    Though something to keep in mind is that offset mortgages are not an option in all locales. The US for example doesn't have them.
    - ajb 5y ago
      Huh, I just assumed that the US would have any financial instrument that was available elsewhere. I guess the same US statutory intervention into the mortgage market, that makes long fixed-rate mortgages possible, also makes it difficult to have custom mortgage instruments?

BuckRogers 5y ago

I haven't done it for a while but when I last compared 15 to 30 year rates the interest was outrageous, pure usury, for the 30 year. But that isn't my main motivation to sticking to a 15 year, it's just a mechanism to limit how much I can borrow and spend. It caps me at a reasonable amount without me having to think about it, while granting a lower interest rate. It just nicely lines up with an amount that my spouse or I can afford with even one job, or a very basic low paying job. I'm definitely doing what you're suggesting and staying away from the edge.

mediaman 5y ago
True, with a 30 year it looks like you're paying a lot of interest, and in nominal terms (i.e., the total amount during the loan), you are. But consider a thought experiment where you could borrow $1m at a low rate of interest, suppose 3%, from a generous lender who requires no collateral and requires an amortizing repayment. You take the $1m and reserve, say, $100k in "no-touch" cash (your cushion) and invest the remainder in the market, and suppose that the market returns an average of 7% over the long run. In this scenario, you obviously pay much more interest than not taking the loan. The interest you pay is nearly $500k, which sounds like a lot - almost half the loan! Yet you make a tidy profit over 30 years: after paying back the loan, you have a portfolio worth over $4 million, plus the $100k reserve you still have. While that's just a thought experiment, the math works fairly similarly for a mortgage. So long as the market returns more (over the long term - it'll be bumpy short term) than the cost of money, you will be paid handsomely for assuming lots of long-term, fixed low-interest debt and investing the proceeds. And this leads to a second surprising conclusion: you should not pay off your mortgage. Once you've built equity, releverage the house and borrow more, so long as you take the proceeds and invest it in an instrument that will pay more than the cost of money over the long run. If interest rates rise, the math might not work. This is bad advice for some people, because a pile of savings and investments can be a tempting target to use for luxury vehicles, or boats or whatever, and that can upset the math, although eventually you make enough with it that might be OK. But for people who can live as if those investments were illiquid, it's quite a rewarding path. And for some people, the psychological value of living in a house with no mortgage exceeds whatever financial gains come from continuing to pay for a mortgage. And while there's nothing wrong with that, it does come at a stiff financial cost.

VBprogrammer 5y ago

Compound interest means that you will be paying a lot more money for the same house if you buy over 30 rather than 15 years. However, for someone disciplined, taking a 30 year mortgage and paying it off like a 15 year mortgage with significant over payments is a good strategy. It means if you need to tighten your belt you can always drop down to the normal payment for a spell without so much as having to speak to the bank. The worst option is to take the 30 year mortgage and then buy the larger house that the longer period allows you to afford.

ajb 5y ago
The answer to this dilemma is to have an offset mortgage. Your savings offset the amount borrowed, and you only pay interest on the difference. Once you've saved enough to cover it, you pay no interest.
- qorrect 5y ago
  Why wouldn't you just buy the house outright at that point ?
  - lostcolony 5y ago
    Fiscal cushion. If an emergency comes up, rather than having no money to pay for it, you instead can cover it, and just pay a little extra each month going forward until you recover. That said, I don't think they exist in the US.
- ineedasername 5y ago
  Though something to keep in mind is that offset mortgages are not an option in all locales. The US for example doesn't have them.
  - ajb 5y ago
    Huh, I just assumed that the US would have any financial instrument that was available elsewhere. I guess the same US statutory intervention into the mortgage market, that makes long fixed-rate mortgages possible, also makes it difficult to have custom mortgage instruments?