Why the 30 Year Mortgage Is Not Your FriendNov 05, 2020
In today’s culture, borrowing money seems to be a way of life. It is the only way most of us obtain those “big ticket” items. In fact, many of us could not fathom how our lives would function if we were not able to finance our lives. So we borrow money, make payments with interest, pay off the loan and thus establish a sound financial history. But what is this was not necessary? What if we could just have a simply life without complication? What if simplicity was the norm?
A good credit history serves us well down the road when we want to purchase other more expensive items especially real estate. Mortgage loans thus make it feasible for the common person to purchase a home or land so that we may “have our own place”.
Such practices are so common place in our culture that we take it for granted. After all, it is these types of financial practices, the ability to buy now and pay later, that make so many things available to us in life. However, are such practices truly in our best interest? Are such practices the best financial decision?
Many people would argue that having a mortgage is the only way they will ever own land or a house. I completely understand that argument because I have borrowed money on several occasions for the same reason. But during the process of doing so, I have learned a few valuable lessons. Allow me to explain by examining a little history.
A SHORT HISTORY LESSON
The practice of having a mortgage to purchase property extends far back in human history, as early as 1190, and it seems to have started in England. As Europeans began to settle the Americas, they brought many of their practices with them. As land and property ownership increased so did the need for mortgages. At least in the United States, by the early 1900s, mortgages were widespread and readily available. However, at the time, not everyone could obtain a mortgage.
For those who were seeking to purchase property, they often had to put up a 50% down payment and the term of the mortgage was 5 years. This practice continued until the Great Depression when there were thousands of foreclosures and the system collapsed.
Then the federal government stepped in with Franklin D Roosevelt’s New Deal which brought sweeping changes to the banking and securities industry and forever changed the structure of the mortgage. These changes gave birth to the Federal Housing Administration (FHA), the Federal National Mortgage Association (Fanny Mae), and promoted fair lending practices. Mortgage-lending funds became easily available.
After World War II veterans began returning home and entering the work force. The demand for mortgages increased and the Veterans Administration was given authority to guarantee loans issued by private lenders. This created a massive economic boom. Furthermore, when baby boomers started entering the work force, double income families became common place. They wanted larger homes and the demand for mortgages increased again. By the 1950s and 60s most mortgages were 20 to 30 years.
In the 1970s interest rates rose significantly. Consequently, the mortgage market had to adapt and mortgage terms were shortened significantly. By the 1980s interest rates rose to more than 21%. By 1998, interest rates had dropped to about 6.5% to about 7.0% and there was about $381 billion in outstanding mortgages. Then along came the financial crisis of 2008 in which housing values fell dramatically. Foreclosures skyrocketed and many people lost their investment.
THE EVER-CHANGING MORTGAGE MARKET
One of the most important decisions that you will make is whether or not to purchase you own home. Since only a small percentage of people can afford to make the out-right purchase, most people are required to take on a mortgage. Despite the fact that the mortgage market has been fraught with booms and busts which have both enriched and impoverished many people, the mortgage still remains as the principle means of purchasing property.
As you can see from the history lesson above, there are many factors that affect the mortgage market that are completely unpredictable and out of your control. The mortgage market changes on a regular basis and is constantly adapting in order to extend home ownership to as many families and individuals as possible. There are hundreds, if not thousands, of programs available that make it possible for people in nearly every economic situation to own a home. You just have to find the right program for you and choose wisely.
CONSIDER THE TRUE COST OF A MORTGAGE
When contemplating a mortgage, you have to take into consideration what that loan is really going to cost you. If you have ever tried to buy a new car, you know that the sales person often attempts to tailor the payments to your budget and diverts your attention away from the “true cost” of the loan. To some degree, we have the same thought process when signing papers for a mortgage. All we see is that we have a payment that we can afford and we can finally be in a place of our own.
However, you really need to take a strong look at what that loan is really going to cost you over time. You also have to consider that once the loan is amortized, you are continually charged interest on the initial loan value, not the remaining principle. Therefore, as you pay down the principle on the loan each month the amount of interest that you are charged does not go down. Also, you need to look at loan origination fees and other up-front costs of the loan.
A REAL LIFE EXAMPLE
I used to own a house on which I carried a mortgage. It was the typical setup where my monthly payment included allotments for principle, interest, mortgage insurance, and escrow for property taxes. My monthly payment was about $1,085, which means I was out of pocket $13,020 per year. Out of that, $2916 per year went toward principle, $1,097 per year for property taxes, $1,640 per year for insurance, and $7,367 per year for interest.
Since I was able to deduct property taxes and mortgage interest on my income tax return, that at least saved me some money by reducing my taxable income. This deduction totaled $8464 per year which means I save roughly $2500 per year in income tax. Over a 5 year period that comes to a savings of $12,500.
At first glance, that appears to be a good deal. However, look at what I had to do to get that kind of savings. Over 5 years I am out of pocket $65,100. During that time, my principle on the loan is being reduced by $14,580 and I am saving $12,500 in taxes. Therefore, the total benefit for me over 5 years is $27,080. That means over 5 years I am out of pocket $38,020 for something that produces zero benefit for me. And this means over the life of the mortgage I will be out of pocket $228,120 dollars for something that produces no benefit to me.
WHAT IS THE ANSWER?
I am not saying that mortgages are a bad thing. It does enable us to buy property that we otherwise would not be able to afford. Most of us cannot come up with the incredible amount of money that would be needed in order to completely avoid a mortgage. But, what we can do is be sensible about how we purchase real estate.
Simply take your time and purchase carefully. Live well within your means and make it possible to save money on a regular basis. Budget yourself over a period of several years and save up a substantial down payment. Keep an above average credit score which will make the loan process go smoother. Prequalify for a loan then purchase property that is well within your means. Start small and build from there. Make sure you purchase a property you are willing to live with for a period of time in case the housing market takes a dive and real estate prices go down.
When I bought my cabin property, I did so without a lot of forethought and planning. All I could see was that I had the opportunity to purchase a piece of land that was exactly what I’d wanted. In the end, things worked out fine. But, life was really rough for several years. Since I had previous construction experience, I was able to build the cabin without borrowing any money to cover the costs. For various larger projects that I was unable to do myself, especially excavation work, I saved the money and paid someone cash. By working in this manner, I managed to pay off the mortgage on the land in 12 years. Furthermore, the cabin is completely off the grid so I do not pay monthly utility bills.
The point is this. There are ways to have you own place and not be in debt for 30 years. With forethought and planning, and perhaps a lot of hard work, you can save yourself a substantial amount of money. Think creatively. Don’t let the financial system put you in a box and dictate how you have to function. Don’t get in debt over your head and lose the freedom to live your life on your terms.
My cabin is very simple. It has all that I need to be comfortable, warm, and safe. And it is paid off. Many of my friends live in much larger, much nicer homes, and drive brand new cars. They also routinely ask me how I can afford to take off for a month at a time and travel. It is because I keep my life simple.
I distinctly remember the look on the banker’s face the day I walked in to give them a substantial amount of money in order to pay off my mortgage. There was a blank stare and someone said, “But no one does that.”
But I did. It is because I keep my life simple.
Here’s to keeping life simple and mortgage free.
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