If there’s ever been a debate that has lingered for years on end is this. It is at the top with the rest of other questions that have existed through ages like, “Should I have children?” “What’s the meaning of life”, and “Does God exist?”
Is it really foolish to prepay your mortgage? What’s the ideal mortgage – is it one that stretches for 15 years or 30 years?
These are some of the mortgage questions most people have.
At this point, it is safe to say if you are looking to purchase a home or you are a homeowner already, a fixed mortgage that runs for 30 years is a good bet.
Judging from the current economic situations and the times we are living in, you are better placed not prepaying any 30-year mortgage or getting a short-term mortgage in the least.
This statement is based on a few inferences:
- You intend to make the house your home for at least a decade.
- You and your partner are below 50 years.
- The cost of owning a home is 30% less compared to your monthly income.
- Your home equity is 25% or more
- You intend to invest the amount (or rather the difference) you save from your mortgage prepay or short term 15-year mortgage.
- The house you bought is not a mansion but a simple average-size, 20,000 square-foot.
- You’re debt free and an investor
This does not mean you are at liberty to do whatever you please or rather buy a costly 5,000 square-foot home.
It is quite the opposite, in fact. Get yourself a simple home to live in, at a safe and serene neighborhood. From the difference, invest the money in a stock market.
Each time you get a home equity loan with low monthly interest rates you can choose to invest the difference.
Judging the greater returns stock market brings in, and the current inflation rates, your financial situation will soar higher than when you invest in a mortgage with high interest rates.
The latter suggests owning a home is cheaper than renting. Dave, on the flipside, hints the devil has a hand in everything (mortgage) debt.
Why a 30-year Fixed Mortgage Is Ideal For You
So, here are three reasons why a 30-year fixed mortgage is ideal for you.
1. You can’t sell off a home quickly
Why? Because it is an illiquid asset. That means you cannot sell it off easily or exchange it for cash without depreciation in its original value.
Then again, such an asset is considered difficult to dispose of as there are no investors willing to purchase it rather quickly.
To put it simply, if you decide to buy a home today there’s no turning back. You can’t get your cash back.
You’re doing it for the long haul because you’ll make it your home for at least a decade or more.
Well, you can always refinance it by taking a home equity line of credit, but then that requires your home to accrue at least 25% or more in home equity. And you must have a stable job.
If ever lose your job it’s difficult to make use of your home’s equity, or take a $5,000 guaranteed loan against your home, lest you want to lose your home. Or have it foreclosed.
This is what Dave Ramsey is trying to highlight. That don’t get yourself into debt if you want to save your home. You must have a good cash flow first before you can get a mortgage.
There is a downside to putting all your money into your home as an asset, though.
Storing too much equity on your primary residence can spell doom for you especially in the case of an emergency. It is important hence to allocate money to different liquid assets.
2. Your primary residence is not an asset
This sentiment was clearly put across by the best-selling author of Rich Dad, Poor Dad, and Robert Kiyosaki.
He said your home is just a residence you living in. It is not an investment if the real estate bubble that took down people’s money is anything to go by.
According to Robert, it makes economic sense to rent compared to buying home if your intention is not to live in the same location for five years or more.
He further says in the book, if you’re not planning to live in the same location for at least a decade or more don’t consider buying a home.
Why? Because it’s financially risky storing all your equity in one illiquid asset.
3. Invest your money. Don’t take a 15-year mortgage
With the availability of cheap credit, according to David, you’re better off investing your money in the stock market than getting a 15-year mortgage.
To give you a clear picture of what David means let’s compare two individuals – without factoring in current inflation rates – both homeowners with a mortgage of $300,000,
- Scenario #1 – John gets a short-term mortgage of 15 years at 3.250%. He pays $2,108 every month as a mortgage payment. He will have accumulated $116,592 after 10 years in mortgage balance. And $183,407 in home equity. John did not invest the difference into the stock market instead he lowered the term of his mortgage.
- Scenario #2 – Mary gets a long-term mortgage of 30 years at 3.75%. She pays $1,389 every month as a mortgage payment. She will have accumulated $234,334 after 10 years in mortgage balance. And $65,665 in home equity.
Mary, on the flip side, invested the difference in the stock market after 15 years. That’s roughly $718.
If this amount say accumulates at a rate of 8% every year for 10 years in the stock market Mary will have at least $131,476 worth of stock investment.
Mary chooses to invest the difference, which significantly grew over time. Even her home equity (against the initial $300,000) soared after having lived in the home for 15 years.
The same cannot be said of John who doesn’t have the same investments as Mary.
Remember once you’ve invested in your home, or rather stored all your equity in an illiquid asset such as a home, it is difficult to get your cash back.
But if you’ve been investing your money, getting a long-term mortgage loan that stretches for 30 years (like Mary did), you can use your investment to pay off your mortgage debt.
It will only get foolish if you prepay your mortgage without any investment. Because, well, inflation rates always increase every year and can affect your home equity.
Or even a real estate bubble can reoccur, and where will that leave you? Broke with too much equity stored in a liquid asset – an asset you can’t easily sell to investors or prospective buyers.
The only logical approach to this is to get a 30-year mortgage, invest the difference in the stock market, and in the process increase your home’s equity.
It makes sense especially in the event of a real estate bubble. It is foolish to go the 15-year mortgage way without any investment.
An emergency can arise or a house market crash can happen like it did back in 2007/2008. This could spell trouble for you and your family in the long run.