Archive for the ‘Debt’ Category
Saturday, November 13th, 2010 |
The topic of paying down one’s mortgage vs. investing seems to be a never ending debate with everyone having their own opinion on which method is better.
The argument for either side of the equation usually heats up over the topic of investment return. While some argue that investing can yield a higher after tax return based on historical figures, others posit that those historical figures are likely not going to be accurate going forward and that finding a ‘guaranteed’ rate of return in the current environment as high as your mortgage rate is improbable.
While both can make good arguments, I am not going to approach the mathematical side of this subject with this article.
The truth of the matter is that everyone’s situation is different and everyone has their own personal views on risk and debt. Truth be told, I firmly believe that we can’t reasonably compare an investment portfolio with one’s personal residence. Therefore, I view this argument as much more emotional than mathematical. It is for that reason that I want to bring to light some of the emotional trigger points that evoke the polar responses often associated with the pay down debt vs. investing debates.
Let’s start with a few basic questions that may help you decide whether it is better for you to invest or to pay down your mortgage.
1.) How many years are remaining on the current amortization of your mortgage?
If you have fewer than 10 years remaining on your mortgage amortization and your rate is fixed until maturity, you may be better off taking the guaranteed return associated with retiring your mortgage early. The reasoning behind this is that, while investments in the stock market may yield a higher return on average, ten years is a relatively short period of time to invest in the stock market. This is especially true when we consider the necessity to achieve after-tax returns greater than your mortgage interest rate.
2.) Do you have the financial discipline to invest 100% of the amount of your mortgage payment once it is paid off?
If you choose to pay off your mortgage prior to retirement, you will have some catching up to do with respect to your investing goals for retirement. While there is peace of mind involved in being ‘mortgage free’, diverting that former mortgage payment to an investing/savings account is the perfect way to beef up your retirement portfolio. the opponents to the pay off the mortgage early plan often cite the tempation for the new found cashflow to lure you in to a lifestyle that you won’t be able to afford once your working days are through.
3.) How confident are you in your investing abilities?
While I like to think that by investing in dividend growth stocks and dividend paying ETFs, I don’t always make the perfect investment. Yes, I even lose money sometimes 
According to the statistics, most of us do not have the ability to consistently out perform the stock market indexes. What’s more, none of us have the ability to move the market which puts us at a further disadvantage. So, I must agree with Five Cent Nickel on one benefit of paying off the mortgage early:
Another advantage of paying off your mortgage early is that doing so protects you from yourself. While paying the minimum on your mortgage and investing the difference might sound like a great idea, there are no guarantees that you’ll actually follow through on the second part of the equation.
4.) What is your current state of job security and liquidity?
This is where we have to take a long, hard look at our personal situations and assess those things that could derail even our best laid plans. If you are confident in your job security and are comfortable with lower liquidity as you aggressively reduce your mortgage, then mortgage reduction may be the decision that is best for you. However, if job security is a question or if you are the sole breadwinner in the household, you may be more inclined to carry a higher level of liquidity (ie. larger emergency fund).
So, what am I doing?
I took a similar approach to this question that The Financial Highway suggests. Look at both the mathematical and emotional aspects of the equation and answer honestly to the above four questions.
Well, I am somewhat confident in my investing abilities, but the emotional side of me would like to eliminate my mortgage. However, the real benefit for me in eliminating the mortgage is in the increased cashflow provided from the complete elimination of the debt.
You see, my mortgage rate is variable and currently at 2.25% 2.50%, so the idea of paying extra payments instead of investing has little merit in reducing the overall interest paid on my mortgage.
Comparatively, saving/investing until I can eliminate the debt entirely will have the effect of keeping my funds liquid as a hedge against job loss or another financial tragedy until such time as I can mitigate the risk of job loss etc. by removing the entire mortgage payment from my liabilities.
What are your thoughts on the invest vs. pay down mortgage debate?
Resources:
Mortgage Pay Down vs. Investing Calculator
Posted in Debt | 6 Comments »
Sunday, August 31st, 2008 |
I have recently received a few e-mail comments from readers asking me to expand on my previous article Understanding Mortgages, this article will answer many of the questions that were posed to me in those e-mails.
Mortgage and Housing Markets
Today’s housing market in most of the United States is a virtual candy store for the homebuyer. The sheer selection of properties on the market in most cities allows today’s homebuyer a tremendous selection at prices we have not seen in many years. There is only one problem however – lenders are tightening the purse strings on mortgage financing!
With lenders becoming more and more risk-averse, obtaining a suitable mortgage these days can often be a daunting task. There are numerous types of mortgages to choose from, and because of some previous “shady” lending practices, you need to make sure that both your lender and your mortgage are on the up and up.
With that said, there are several different types and structures of mortgages with various options to consider before committing yourself to such a large obligation.
Once you have settled on a legitimate mortgage with acceptable terms and conditions, there is the issue of the interest rate. Which option you choose will depend on your circumstances, but visiting your lender armed with the knowledge of the basic differences in terms and conditions will give you the confidence to get the best deal.
Here’s a quick guide to some different types of mortgages:
Fixed Rates
With a fixed rate mortgage, you agree with the lender on a set period of time – usually between two and five years – during which the interest will not change. The benefit here is that you will not suffer an increase if rates go up. Similarly, you won’t benefit if rates go down, and the borrower will likely face stiff penalties in order to pay out the mortgage early. As intriguing as a low, fixed rate interest plan may seem, you must check how long you are required to remain with the lender before you can pay out the mortgage without penalty.
Variable Rates
The amount you pay for your mortgage alters in line with national interest rates. Normally, the interest reflects the changes in the base lending rate of the central bank; this is decided by the Federal Reserve whom control the monetary policy for the country. Every time the Fed raises the overnight rate, the lenders eventually follow suit because their cost of funds increases. And in order for the lender to make money there has to be a “spread” between its cost of funds (the rate the bank pays to borrow money) and what the back charges to lend that money to the consumer.
Capped Rates
The idea behind capped rates is to offer the best of both fixed and variable rates. A “cap” is set on the interest so that it will never rise above that level, but if national rates fall, your interest will go down accordingly. The benefit of these is that you know the maximum interest rate that you could end up paying. However, the capped rate is not generally very competitive.
Discounted Rates
Discounted rates will fluctuate in line with the lender’s variable rate, but are obviously cheaper to tempt customers in. After the discount term has ended, the rate will then revert to the normal variable rate.
Banks and companies offering mortgages are now required to supply customers with a key facts document that provides all relevant information relating to the loan, and clearly sets out the total cost of the loan, not just the interest.
What Else Can affect My Mortgage Rate?
Along with the various types of mortgages available, there are a few other things that can affect the rate of interest that you will be charged on your mortgage.
One of the major factors that will affect the rate of interest that a lender will charge for your mortgage is the risk that they perceive they are taking by lending money to you. The major tool that lenders use to judge risk is your credit score. A better credit score will result in a lower mortgage interest rate because you are determined to be a lower risk than someone who has a lower credit score.
Do Your due Diligence
Whichever mortgage you choose, make sure you thoroughly research every option and compare lenders. You are, after all, bound in to the agreement for a long-time, and it’s sensible to make sure you get it right first time as switching lenders can involve hefty penalties. Lenders may have significantly different terms and conditions for their mortgages.
Remember, that it doesn’t matter how low an introductory rate is if it will significantly increase in 6-months or 1-year. Be sure that you read the fine print and calculate the actual costs of the mortgage over the entire amortization period.
There are plenty of great homes out on the market right now and there are a ton of reputable lenders who will be happy to lend money for home purchases. The key is to be knowledgeable and well prepared when applying for a mortgage so that you ensure that you get the best mortgage for your situation.
Happy house hunting!
Posted in Debt | 2 Comments »
Thursday, March 20th, 2008 |
Don’t Talk About Moving When Your Wife Is Pregnant
I’ve recently had a discussion with my 9-month pregnant wife about the idea of moving. Now, I should have known better than to approach that subject when my wife is in her “nesting” mode – needless to say she was not happy.
The reason that I brought up the subject is that we can literally choose to live wherever we like. There is nothing holding us back from moving anywhere that the respective laws allow. I began thinking about this subject as I have watched home values in my city double over the last two years.
My Thoughts
We have made a couple of really savvy real estate deals that have made us more money over the past two years than our respective salaries. This, along with minimizing our expenses has put us in a comfortable position with no consumer debt and an increasing net worth.
Because our only debt is our mortgage, I have been toying with the idea of selling our house and moving to a less expensive location whereby we can purchase a similar home and be completely debt free.
In my mind this makes a lot of sense, here’s why:
- We would not be enslaved at jobs that we may not enjoy because we need to make a mortgage payment.
- We could plow a lot of money into other investments at the age of 29, with a long time horizon to watch it compound.
- We could spend money on travel and experiences that produce life-long memories, which is more valuable to me than “stuff”.
- We could choose to take extended “vacations” from our jobs to spend with our new child and extended family.
Rationale
- We both have Master’s degrees and are highly employable in any location. Even in a remote location, we could easily make ends meet by telecommuting or freelancing.
- Our city is freakin’ cold in the winter – what is the advantage to that?
- We would be further from extended family, but with the added freedom of not having a mortgage, visiting would be less taxing on the pocketbook.
(To be honest, we see our extended family only slightly more than when we previously lived much further away)
- Real Estate values are bound to cool at least slightly as evidenced by the “trendy” markets in the United States and Canada. I’m not calling a top to the housing market in my city, but I’m not greedy either – freedom is very tempting.
Making a move to a slightly smaller city less than three hours rive from our current location, with good job prospects for the both of us could set us completely debt free under 30 years of age. Most importantly, it would do so while living the same lifestyle that we are accustomed to. This is something that I find very tempting. (The winter would be just as cold though)
Of course it was seriously bad timing on my part to bring this up due to the pending birth of our first child. However, it has been eating at me ever since we did our annual budget in January and I realized the possibility.
Complete freedom from debt is a huge goal of mine; but is this the right way to achieve it?
I’d love to hear your stories or thoughts on this matter. Feel free to share in the comments!
Posted in Debt | 2 Comments »
Tuesday, March 4th, 2008 |
It appears that I shocked a few people when I wrote about my thoughts on maxing out your student loans to get every penny that you can. Of course, there are the same arguments about other kinds of debt as well. I have received my fair share of email regarding my advice on the use of debt.
Debt is a Tool.
It is that simple.
Loans, mortgages, credit cards etc. These are all tools that, if used correctly, can not only help you manage your cash flow but increase your wealth as well. Yes, debt can be terrible if you can’t control it, but it can also be your best friend if managed correctly.
I already talked to you about the power of using a mortgage as leverage to build wealth and why lenders are more eager to hand out money when it is backed by an asset such as real estate versus consumer debt – like a car loan!
Why is This Article Titled “Student Loan Strategies”?
Well, as mentioned in the previous article on student loans, the student loan is some of the easiest money (debt) that we can obtain as average individuals. It is even easier to obtain than a mortgage because you are not required to prove that you have an established income. The debt is backed by your future earnings – how’s that for pressure!
Anyway, as we get back to the moral of the story and we understand how we can leverage our student loan money so we might graduate without a negative net worth, there is a way to combine the above strategies in order to profit while getting your degree.
Kiss The Dorms Good Bye!
This strategy is directed toward the parents of children who are on their way to college. So, if you are a college student, or about to be one get your parents on the phone!
To the parents…
Your child will have to live somewhere and either you or they will have to foot the bill regardless of where they hang their hat, so why not profit from it?
The strategy is to purchase a house with as many bedrooms and bathrooms as possible in a location that is as close as possible to the university. Yes, you will be renting this house out – but your child will be managing the rental.
College rentals can be unique and very profitable in that it is possible in this situation to rent “by the room”. While most residential real estate rents by the unit or the house, the college market will allow increased returns by renting by the room.
An Example
A 4 bedroom home that would normally rent for say $1000/month as a unit can often be rented by the room in the college market for between $350 and $450/month per room. As you can see the potential for profit is much higher and the potential for your child graduating without a mountain of debt it also greater.
This strategy requires more management as you must collect rent from each person separately instead of collecting one check from the entire house. If you trust your child and they are responsible, this should not be a huge issue as they will be living there to manage the property.
This will also help your child to learn to better manage finances and learn business skills such as management, marketing and basic accounting.
The Benefits
Ideally, the monthly profits (cash flow) from the roommates can cover expenses, repairs, vacancies etc. or may be used to have your child live, essentially, for free!
However, the best part about this strategy is that over the course of the 4-5 years that your child is in college, you will be gaining equity in the home courtesy of your child’s college roommates. This equity can be crystallized by selling the home when the child graduates and using the equity to pay off the student loans for example.
If you have a steady income and a good credit score, buying a house for your child to live in while going to college is typically a sound strategy.
The Kicker
If you have more than one child that attends the same university, this strategy can have a compounding effect as the younger ones enter school and the rooms continue to be rented out, your equity grows and grows.
If you are fortunate enough to realize a substantial capital gain along with your home equity, you executed this strategy exactly as my good friend and his parents did when I attended college. I only wish my parents and I could have undertaken this strategy instead of paying off someone else’s house!
I hope you enjoyed this example and are able to benefit from it. I share this with you, not because I profited from it, but because I was a victim of it! If it helps your child start their professional life without the same $40,000 in student loan debt that I had, then it has been worth the time to write this article.
Stay tuned later this week when I will tell you a story about what I learned from falling victim to this strategy and how it catapulted my net worth right out of college!
Posted in Debt | 9 Comments »
