In June, existing-home sales rose 2.6% from May to a seasonally adjusted annual rate of five million, according to the National Association of Realtors. As usual, a majority of buyers took out a mortgage. The hefty loan involved fundamentally alters the finances of these families -- and opens up some intriguing opportunities.
Recently bought a house? Here are nine ways to think about that debt you just took on.
1. It's your cheapest way to borrow.
I'm not crazy about carrying debt. But if you need to borrow, a mortgage is the way to go. The interest incurred is typically tax-deductible and the rate should be low, in part because the loan is secured by your home. If you have other debt, you probably could lower your borrowing costs by paying off those loans and instead carrying a larger mortgage.
2. It's a negative bond.
Got a $200,000 mortgage and $200,000 in bonds? One is costing you interest while the other is earning you interest, so arguably your net bond position is zero. In fact, the rate on your mortgage is likely higher than the yield on your bonds, so it might make sense to sell bonds to pay down your mortgage.
3. It leverages your entire financial life.
We all engage in mental accounting, thinking of our home and mortgage in a different bucket from, say, our brokerage account. But once we have that mortgage, it effectively leverages our financial life, allowing control of more assets than if we didn't have the loan.
Suppose you own a $400,000 home with a $300,000 mortgage. Your only other significant asset is $200,000 in stocks. In effect, what you have is a $600,000 real estate-and-stock portfolio, half of which is bought with borrowed money.
That leverage magnifies gains and exaggerates losses, in the same way you can magnify gains and losses in a brokerage account by buying on margin. But a mortgage is the safer way to borrow.
While a brokerage firm can force you to repay a margin loan if your investments plunge in value, your mortgage lender can't demand its money back if your home tumbles in price.
4. It's a backup source of emergency money.
If you've built up some home equity, consider setting up a home-equity line of credit. That way, if you suddenly get hit with large medical bills or house repairs, you can borrow against your home's value.
5. It makes inflation your friend.
Like other hard assets, real estate tends to hold its value when inflation picks up. Also got a mortgage? You could be doubly protected against inflation.
The payments on a fixed-rate mortgage stay the same even as inflation rises, which means you can repay the loan with dollars that are less valuable. Adjustable-rate mortgage borrowers don't benefit to the same degree, because their interest rate will likely rise with inflation, though there are typically caps on how much and how fast the rate on an ARM can climb.
6. It lets you profit from falling interest rates.
If you have a fixed-rate mortgage and rates rise, you can sit tight with your low-cost mortgage. But if rates fall, you can refinance at the lower rate. Indeed, with 30-year mortgages still available at less than 4½%, this remains a great time to refinance.
7. It's an effective way to build wealth.
Despite the recent property slump, many folks still say their home is the best investment they ever made. It isn't because homes have enjoyed great long-run price appreciation. Over the past 30 years, prices nationally are up 3.6% a year, as measured by theFreddie Mac FMCC -0.26% House Price Index. That's barely ahead of the 2.8% inflation rate.
Instead, homes build wealth by forcing folks to save. With every monthly mortgage payment, you trim the loan's principal balance—and eventually you should own a valuable asset free and clear.
8. It's your default investment.
If you're worried about today's lofty stock valuations and lowly bond yields, you could always pay down your mortgage instead. Suppose your mortgage is costing you 5%. That's the effective pretax rate of return you earn by making extra-principal payments.
9. Paying it off can drastically reduce your cost of living.
Indeed, making that last mortgage payment is often the signal that retirement is finally affordable. Want to retire early? You might make extra-principal payments, with a view to getting your mortgage paid off ahead of schedule.
Write to Jonathan Clements at SundayJournal@aol.com
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