A mortgage broker I was introduced to recently just sent me this article on 10 Great Reasons to Carry a Big, Long Mortgage by Ric Edelman. Apparently Mr. Edelman is the expert to be quoted on this subject, as I’ve heard his name associated with this idea several times. Here are his ten reasons along with limited excerpts of the original article. My response is included at the end.
Reason #1: Your mortgage doesn’t affect your home’s value.
You’re buying your home because you think it will rise in value over time. Yet, the eventual rise (or fall) in value will occur whether you have a mortgage or not. So go ahead and get a mortgage: Your house’s value will be unaffected.
Reason #2: You’re going to build equity anyway.
Many homeowners try to build equity in their house by paying off the mortgage. But that produces weak results when compared to the equity you?ll build simply by watching the house appreciate in value. So go ahead – keep the mortgage. You’ll build plenty of equity anyway.
Reason #3: A mortgage is cheap money.
[...] You’ll find that mortgages offer you perhaps the cheapest way to borrow. Mortgage loans offer low interest rates because you post the house as collateral: If you fail to repay the loan, the lender sells your house to recoup its money.
Reason #4: Mortgage interest is tax-deductible.
Not only are mortgage loans low in cost, the interest you pay is tax-deductible. You can save as much as 35 cents in taxes for every dollar you pay in interest. That means a 6% mortgage loan really costs as little as 3.9%. Why carry 18% credit cards, paying interest that is not tax-deductible, when you can instead carry a 6% mortgage with interest that is tax-deductible? Your mortgage is probably the cheapest money you can borrow, so it makes sense to get as much of it as you can.
Reason #5: Mortgage interest is tax-favorable.
Assume you have both a 6% mortgage and a 6% profit on your investments. The mortgage is deductible at your top tax bracket, but the investments are taxed as low as 15%. For someone in the 25% tax bracket, that means the mortgage costs them 4.5% while the investment nets them 5.1% after taxes. In other words, tax law makes it beneficial for you to maintain your mortgage.
Reason #6: Mortgage payments get easier over time.
[...] You might be struggling to make your mortgage payment at first, but over time you can expect your payments to become cheaper relative to your income – especially if yours is a fixed-rate loan. That way, your payment never rises, but your income does.
Reason #7: Mortgages let you sell without selling.
In time, you may well find that your home has grown substantially in value, and you may begin to worry that you might lose that equity if there’s a decline in real estate values. You don’t want to sell the house, which is the obvious way you can capture the value, but there is another answer: get a mortgage. By cashing out some of the equity, you essentially collect the value of the house in cash without actually having to sell the house.
Reason #8: Large mortgages let you invest more money more quickly.
Assume you own a house and want to buy a larger home. So you sell your old house and net $300,000. Now you’re ready to purchase a new $500,000 home. How much should you put down? Should you make a 10% down payment of $50,000? Or should you put down the entire $300,000 in proceeds from the sale of the old house?
Big mortgages mean small down payments. Small down payments mean you retain lots of cash that you can then invest.
Reason #9: Long-term mortgages let you create more wealth.
Do you merely want to eliminate your debt, or do you want to truly build wealth? Please realize that the former does not automatically result in the latter. Indeed, many people who are debt-free are also dead broke.
So, the real goal is to create wealth. You do that by adding as much money as you can to your savings and investments. And the best way to do that is to lower your monthly expenses. That’s why long-term loans are better than short-term loans: the longer the term, the lower your monthly payment. And the lower the payment, the more money you have left over that you can place into investments.
Reason #10: Mortgages give you greater liquidity and greater flexibility.
(Long story about Sam and Nick).
I’m not going to refute any of his overall points – they are mostly true but his main problem is that he tends to overgeneralize. Instead, I’ll just say that the basic premise of this argument is actually very simple. Essentially you are trying to perform an arbitrage – you wish to borrow money cheaply (mortgage), and you invest it at a higher rate (stocks), with the difference being your profit. This is very similar to what people do with 0% balance transfers and 5% savings accounts.
However, an important difference is that you don’t know what your investment returns will be, and the arbitrage gap is not definite. Edelman uses in his Sam/Nick story an assumed annual return of 8% after taxes. He doesn’t acknowledge that there is no investment product that Sam can buy that guarantees that (very optimistic) return. In reality, people invest in expensive mutual funds with varying returns, endure tax consequences from frequent trading, or attempt market timing with bad results. The market may return 8%, but the average person might only get 6% after all is said and done. Someone will do worse, others will do better. Of course, most people think they will do better…
As other have put it – If someone walked up to you an offered you a credit card with a 5% APR for life with no cash advance fees or other catches, would you use it to buy stocks? Say you expect 8% investment returns. Does that mean you’d even borrow money at 7.8%? There’s got to be some room for error.
If I had a 5% mortgage rate and had a lot of itemized deductions, I would be pretty comfortable not paying it off early – especially if I had not maxed out my contribution to tax-deferred accounts like 401ks yet. However, if I had a 6.5% mortgage rate and had lost my interest deduction due to the AMT, it would be a much closer call. In that case, I would probably treat paying it off like a bond.