I saw his seemingly direct question and was surprised that I had never answered it.
I’ve been writing about mortgages on this blog since 2006, so chances are I’ve covered a lot of things.
But I rarely think in terms A mortgage is optional. For many, it’s a must, given how expensive homes are these days.
Few people can buy a property with cash, so a mortgage is often offered when we discuss buying a home.
That being said, we can discuss the pros and cons of getting a loan (and keeping it for a long time).
Pretty much Everyone Needs a Mortgage
First things first. If you’re reading this and want to buy a home (or already own a home), chances are you need or have a mortgage.
It just doesn’t work to buy a home with a lot of money for people.
Your average American can’t even put together a 20% down payment, so the chances of them buying a home are slim.
But beyond that, even those who can afford to buy a home with cash often don’t. just look at Beyoncé or Mark Zuckerberg.
When given the opportunity, they still choose to borrow money. Why? Because financing often plays better than locking up all their money in illegal investments.
Their money is better spent (theoretically) in other investments, whether it’s the stock market or something else.
All they really need to do is find a rate of return that is higher than the interest rate on the loan.
In addition, they get a diversity bonus. Do you really want all or most of your money tied up in one thing? A home, which is vulnerable to hazards, such as wildfires or floods.
You’ve heard the saying “don’t put your eggs in one basket,” and this applies to real estate as well.
Is It Better to Have No Loan?
Okay, so we know that the rich and the poor often choose a home loan instead of paying cash for a property.
But is it better not to have a loan, which means you will eventually pay off the loan and hold the property free and clear?
One might argue that for the average person, yes, you have to eventually pay off your mortgage.
After all, you pay a lot of interest each month along with the principal, and it’s about the most expensive part of your monthly bill.
If you can remove the loan from your debt list, you will have more money on hand for other expenses or investments.
And you won’t be paying a lot of interest to the bank every month, which can be a good thing.
This is especially true if you are close to/nearing retirement, as it is often recommended not to take out a retirement loan if you are going to have a fixed income.
However, there is a big difference between paying off a loan and prepaying a loan.
The latter means that you voluntarily and diligently CHOOSE to allocate your extra money to the home equity each month.
If so, you need to consider the loan amount as your rate of return for making that “investment” you realize.
What About Homeowners with 2-4% Fixed Rate Loans?
Let’s consider that question of payment versus prepayment for a moment. Today, most homeowners have a mortgage rate of less than 5%.
At first glance, it looks like 75% of mortgage holders have rates below 5%. And about 40% have an average of less than 4%, according to FHFA data compiled by Lance Lambert.
Many more millions have rates in the 1-3% range. Yes, rates start at 1%. This is a unique event related to the Fed’s Quantitative Easing (QE) program, which has since ended.
That included buying trillions in mortgage-backed securities (MBS) to lower mortgage rates.
So today, homeowners probably look at mortgages in a very different way than before.
The long-term 30-year fixed rate is about 7.75%, and we all know that mortgage rates in the 1980s were as high as 18%.
This means that the argument for taking out and keeping a mortgage is night and day compared to those days.
If you talk to an older homeowner, they may be biased to pay it off as soon as possible.
But if you talk to a young homeowner, what might they say is too hasty? I want to keep this thing as long as possible.
In other words, context matters and you need to look at your interest rate and loan type to make this determination.
No universally bad mortgage or debt is a good answer. Like most things, it depends.
A home buyer today who can only get a 7% mortgage may have a completely different view of mortgages, and for good reason.
Personally, I don’t like debt, which means I don’t like to take on any debt, but I’m in debt and I believe that a mortgage is generally good debt.
Check the Status to Determine If a Mortgage Is Right for You
As noted, most of us NEED a mortgage. It’s not even a question you’ll consider when buying a home because you’ll have no other choice.
However, you still have the option to pay off your loan early. So that’s something to consider once you get a loan.
The answer to that question will likely depend on what type of loan you have and what your interest rate is.
As a general rule, those with fixed-rate loans set at very low interest rates will want to keep their loan for a longer period of time, possibly to maturity.
Conversely, those with high-interest mortgages will have to sit back and consider paying it off early, assuming they won’t be able to earn more money elsewhere, such as in a retirement account.
There is no one-size-fits-all solution, so you will need to put in the time and do the math to make this determination. You might even consider a financial planner to help you with this question.
The Pros and Cons of Having a Loan
Good
- Mortgages are cheap loans compared to other options
- Can get a fixed rate for a long time (30 years fixed)
- It allows you to put less down on your home purchase
- It creates asset diversification with cash available for other investments
- Homeowners insurance is required (it’s generally not a good idea to waive it)
- It is generally easier to qualify for all things being equal
- Have the option to prepay or repay if you want
Bad
- There are closing costs associated with a mortgage
- It may take 30-45 days or more to receive one
- You have to pay interest every month to the lender
- Because most loans last 30 years equals a ton of interest
- He may carry the loan until retirement, which is often not advised
- It requires you to carry a certain level of homeowners insurance
Read on: Do I really own my home if I have a mortgage?
Before creating this site, I worked as an account manager for a real estate broker in Los Angeles. My experiences in the early 2000s inspired me to start writing about mortgages 18 years ago to help prospective (and existing) home buyers better navigate the mortgage process. Follow me on Twitter for the latest.
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