I saw his seemingly obvious question and was surprised that I never addressed it.
I’ve been writing about mortgages on this blog since 2006, so I’ve probably covered most things.
But I rarely think about it Mortgage is a choice. For most people, this is mandatory, given the high house prices these days.
Few people can afford to purchase a property with cash, so a mortgage is often taken for granted when we discuss purchasing a home.
However, we can discuss the pros and cons of getting a mortgage (and keeping it for the long term).
Pretty much everyone needs a mortgage
First things first. If you’re reading this and want to buy a home (or already own one), you probably need a mortgage or have one.
It is not practical to buy a home with cash for the majority of residents.
The average American can’t even afford a 20% down payment, so the chances of buying a home right away are slim.
But beyond that, even those who can afford to buy a home with cash often can’t. Just look at Beyoncé or Mark Zuckerberg.
When given the opportunity, they still chose the mortgage. Why? Because financing is often better than locking all their money in an illiquid investment.
Their money is better used (in theory) in other investments, whether it’s in the stock market or something else.
All they really need is a higher rate of return than the interest rate on their mortgage.
Moreover, they get the bonus of diversification. Do you really want to tie up all or a lot of your money in one thing? A home exposed to hazards, such as wildfire or floods.
You’ve heard the phrase, “Don’t put your eggs in one basket,” and that applies to real estate as well.
Is it better to be mortgage-free?
Well, we know that the rich and not-so-rich often choose to take out a home loan instead of paying cash for the property.
But is it better to be mortgage-free, which means finally paying off the mortgage and retaining ownership free and clear?
One could argue that for the average person, yes, you will eventually have to pay off your mortgage.
After all, you’re paying a lot of interest each month and principal, and that’s likely to be an expensive portion of your monthly income.
If you can remove a mortgage from your list of liabilities, you will have plenty of cash available for other expenses or investments.
You won’t be paying as much interest to the bank every month anymore, which is arguably a good thing.
This is especially true if you are nearing retirement, as it is generally recommended not to take out a mortgage in retirement if your income is fixed.
However, there is a big difference between a mortgage payment and a mortgage prepayment.
The latter means that you voluntarily and actively choose to allocate more of your money to the mortgage each month.
If this is the case, then you need to consider your mortgage rate as your rate of return to make this conscious “investment.”
What about homeowners with 2-4% fixed rate mortgages?
Let’s think about the issue of pay versus prepaid for a moment. Today, the majority of homeowners have a mortgage rate of less than 5%.
At last glance, it appears that 75% of mortgage holders have interest rates below 5%. About 40% have a rate of less than 4%, According to FHFA data compiled by Lance Lambert.
Many millionaires have rates between 1-3%. Yes, rates start at 1%. This is a unique phenomenon related to the Fed’s quantitative easing program, which has since been shut down.
This necessitated the purchase of trillions in mortgage-backed securities (MBS) to drive mortgage rates down.
So, in today’s day and age, homeowners likely look at a mortgage much differently than they did in the past.
The long-term average for 30-year fixed bonds is about 7.75%, and we all know that mortgage rates in the 1980s were 18%.
This means that the case for getting and keeping a mortgage is night and day compared to those days.
If you talk to an older homeowner, they may still be biased toward paying off the amount as quickly as possible.
But if you talk to a younger homeowner, he or she might say, “What’s the rush?” I want to keep this thing as long as possible.
In other words, context matters and you need to consider your interest rate and loan type to make this decision.
There are no bad universal mortgages or mortgages are a good answer. Like most things, it depends.
Today’s homebuyer who can only get a 7% mortgage may have a very different view of a mortgage, and for good reason.
Personally, I hate debt, which means I don’t like to take on any debt, but I’m pro-mortgage and I think mortgage is good debt overall.
Evaluate the situation to determine if a mortgage is right for you
As mentioned, most of us need a mortgage. It’s not a question you’ll think about when buying a home because you won’t have any other choice.
However, you will still have the option to pay off your mortgage earlier. So this is something to consider once you get a loan.
The answer to this question will likely depend on the type of loan you have and the interest rate.
As a general rule, those with fixed-rate mortgages and very low interest rates will want to hold on to their loans longer, perhaps until maturity.
Conversely, those with loans with higher interest rates will need to sit back and think about prepaying them, assuming they can’t earn more money elsewhere, such as in a retirement account.
There is no one-size-fits-all solution, so you will need to take the time and do the math to make this decision. You can also consider a financial planner to help you with this question.
Pros and cons of getting a mortgage
Goodness
- Mortgages are cheap debt compared to other options
- A fixed rate can be obtained over a long period of time (fixed for 30 years)
- They allow you to put a little money toward purchasing a home
- Creates asset diversification with funds available for other investments
- Requires homeowners insurance (generally not a good idea to give up)
- It is usually easy to qualify all other things being equal
- You have the option to prepay or refinance if and when you want
The bad
- There are closing costs associated with a mortgage
- It may take 30 to 45 days or more to get one
- You have to pay interest every month to the lender
- Because most loans last for 30 years, they rack up a ton of interest
- The loan can be carried into retirement, which is generally not recommended
- It requires you to carry a certain level of homeowners insurance
Read on: Do I already own my home if I have a mortgage?
Before creating this site, I worked as an account executive for a wholesale mortgage lender in Los Angeles. My work experience in the early 2000s inspired me to start writing about mortgages 18 years ago to help potential (and current) homebuyers better navigate the home loan process. Follow me on Twitter for hot takes.
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