Will Austin Home Prices Continue to Increase? (Rule: loan, how much)

[hts]

Just so we're all clear, I have nothing against refinancing for a lower rate if/when it makes financial sense (ie, you plan to remain in your house long enough to recoup the closing costs--typically a no-brainer).

My issue is converting from a 30 (or even a 40) to a 15 or 20 year term. If you really want to pay off your mortgage early (and I would argue against it for most folks, as it usually makes more sense to invest in the market with that capital rather than retire a mortgage early), simply make extra principal payments. There's is nothing stopping anyone from refinancing their 30-year note to a lower rate 30-year note, and if/when it makes sense to pay down a little extra principal (I'm in sales and receive my commissions quarterly), then write a check to the bank for some extra principal. That way you have the financial flexibility to save/invest/spend the extra cash on a regular basis but can still pay the mortgage down faster if/when you want to (but aren't forced to the way you would be if you locked yourself into the mandatory higher monthly payments required with a 15-year note).

[austin-steve]

Originally Posted by hts

Steve, not true and I respectfully have to disagree.

While owning one's home free and clear has always been perceived to be the American dream, it's often a poor financial decision.

With today's interest rates being as low as they are (I was quoted 4.125% on a 30-yr fixed just yesterday/Friday, without any shopping around), it often makes *much* more financial sense to NOT pay off one's mortgage early, but rather take that same cash (in your case, $400/mth I believe) and invest it in the market.

More specifically, while paying off one's mortgage can lead to financial peace of mind for some, that extra $5k last year ($400k/mth approx for 12 mnths) would have returned the equivalent of roughly $3,300 (after 1/3 tax deduction) to the homeowner if used to pay down one's mortgage, whereas the same $5k would have returned approximately 30% (pre-tax) had it been invested in just a simple S&P 500 index fund in 2013 resulting in a potential value of more than $6,500 at year's end (or a difference of more than $3k).

Assumptions/caveats: Yes, I'm obviously simplifying the math here, the whole $5k wouldn't have been investing on Jan 1, everyone's situation is unique and obviously we can't expect the market to return 30+%/year, yadda, yadda, yadda, but my point is that most people fail to grasp the concept of opportunity costs and leveraged assets. I'm actually contemplating a 40-year mortgage just so I can potentially invest even more in the market (and I'm not talking risky derivatives, just simply Vanguard S&P500 and Total Market indices).

I agree the 15 year option isn't best for everyone, but your rationale is flawed.

1) I'll take a guaranteed return over the stock market any day. With a 15 year loan, you pay a lower total amount to own the home because of the interest expense savings. That's a guaranteed return on the payment increase whereas the stock market is not as safe as you describe.

2) In addition to the interest expense savings, when the 15 year loan is paid off, it frees funds that can be invested or reallocated to other needs. If the home owner decided to invest in the stock market with the monthly payment savings after the "free and clear" date, for the remainder of the life of the original 30 year loan, you'd have to add the expected return from that investment to the interest expense savings to get the true total return of converting from a 30 to a 15.

There are plenty of other factors, but I think what I originally said is true, that it makes sense for anyone able to do so and comfortably afford a refi from a 30 to a 15 year note to do that. Assuming the 30 is not already substantially paid down and the refi is for only the principle amount (no cash out).

Steve

[riaelise]

Steve, by the time you finish paying your 15 yr mortgage off, you will probably either be close to 60 or at 60. No different than a buyer who purchases in their 20s, stays in the home for the 30 years. Just like you feel that getting a 15 year mortgage is the best thing to do, I think that simply sending extra payments is just as good and as hts stated, you aren't locked in to a substantially higher payment. Let's say if someone loses their job? Medical expenses. You name it. It's better to have a smaller mortgage.

[hts]

Steve, I understand you're a realtor, but I do have to question your financial judgment.

If you think that (other than for peace of mind) paying off a mortgage that is likely to be in the 4% range (or a 3% effective rate of return after taxes) is superior than an investment of the same amount of capital in a market that has historically returned greater than 9%, then we're simply going to have to agree to disagree on this one.

This reminds me a little bit of a t-shirt I bought for one of sons last year. The front of it reads something like "I can explain it to you, but I can't understand it for you." No offense intended. :-)

[balor123]

There are many who believe that the historical returns of the stock market are an anomaly and, if for no reason other than demographic changes, are unsustainable over the long term. Those projections still put returns higher than paying down a mortgage but there are nonetheless other reasons to do so. For one thing, life, and finances, are complicated. Paying down the mortgage is one way of greedily ensuring that one spends within their means. The return also needs to be justified by the risk. Stock market returns are notoriously volatile even over large 20-30 year periods. Most of the time you do well but not always. On the more practical side of things, houses are often protected in ways that other assets are not. In case of bankruptcy, for example, your home equity often can't be touched while your investments, even your 401k and IRAs, could be. You won't default on your mortgage and lose the place if you fall into a coma for a few months. On the flip side, if housing crashes or a big uninsured event like a flood destroys your building, paying it off you lose the ability to walk away and leave GSEs holding the bill.

I paid down my mortgage to get a conforming loan, as the return on the drop in interest rate at the time was very good. This post could become much larger but to cut to the chase, both are fine choices and whether to pay it down or not roughly boils down to where do you want to take your risks in life. There's not a right answer here.

[austin-steve]

Originally Posted by riaelise

I think that simply sending extra payments is just as good and as hts stated, you aren't locked in to a substantially higher payment. Let's say if someone loses their job? Medical expenses. You name it. It's better to have a smaller mortgage.

Sending extra payments isn't as good because the interest rate is still higher, and few people have the discipline to methodically send extra payments.

Also, I've clearly predicated the "15 year can be better for most" on the assumption that the 15 year note payment is affordable for the particular borrower.

Originally Posted by hts

Steve, I understand you're a realtor, but I do have to question your financial judgment.

If you think that (other than for peace of mind) paying off a mortgage that is likely to be in the 4% range (or a 3% effective rate of return after taxes) is superior than an investment of the same amount of capital in a market that has historically returned greater than 9%, then we're simply going to have to agree to disagree on this one.

This reminds me a little bit of a t-shirt I bought for one of sons last year. The front of it reads something like "I can explain it to you, but I can't understand it for you." No offense intended. :-)

I offered specific rebuttal to your rationale. You haven't responded specifically but instead offered insults based on your assumption that you're a superior thinker and I'm some sort of financial idiot. All while clinging to the ridiculous notion that the stock market offers risk free return of 9% that can be relied upon. By the way, 3-4% risk-free return (not sure how you came up with that but will go with it to make the point) is better than anything available on the market today in CDs or otherwise, so it's a perfectly reasonable alternative.

Every property I own is now on a 15 year note. The only ones I didn't refi are the ones close to free and clear already. I practice what I preach. I'm 51 and in 5 years my wife and I can quit working the rest of our lives and never run out of money, so I'm quite happy with my financial decisions.

If you can achieve good results your way, and achieve financial freedom, go ahead. But don't tell me you can explain something but not understand it for me, while not responding to the obvious holes in your arguments.

Steve

[hts]

Steve,

I'm sorry if you took offense to my attempt at humour--as I clearly indicated, that wasn't my intent. That being said, we're obviously going to have to agree to disagree on this one.

But, since you insist, I will take the time to respond specifically to your points in the interest of helping others that may peruse this forum to better understand my side of the issues.

<Steve:>
1) I'll take a guaranteed return over the stock market any day. With a 15 year loan, you pay a lower total amount to own the home because of the interest expense savings. That's a guaranteed return on the payment increase whereas the stock market is not as safe as you describe.<Steve>

<hts> Can't disagree with you here. If you're comfortable with a guaranteed return of whatever your interest rate is (3.5-4% would be my guess), then more power to you. I never said the stock market was safe. I said that it has historically returned greater than 9% (a fact). You are choosing a guaranteed 3.5-4% rate of return, whereas I am comfortable in taking that same amount of capital and rather than paying down a mortgage earlier than its due (and thereby guaranteeing myself a 3.5-4% rate of return), I'm willing to roll the dice in the markets. Last year, my total stock market index fund (a diversified and fairly conservative investment by most any measure, I might add) returned 33.5%. For the past 5 years, it's averaged better than 20% (per year). Obviously this issue boils down to risk tolerance--you're not willing to take the risk and I am. While there is no right or wrong answer here, one cannot dispute the fact that my investment decision to put capital to work in the marketplace has paid off much better than your decision to pay down a low-interest rate mortgage earlier than necessary.<hts>

<Steve> 2) In addition to the interest expense savings, when the 15 year loan is paid off, it frees funds that can be invested or reallocated to other needs. If the home owner decided to invest in the stock market with the monthly payment savings after the "free and clear" date, for the remainder of the life of the original 30 year loan, you'd have to add the expected return from that investment to the interest expense savings to get the true total return of converting from a 30 to a 15.<Steve>

<hts>I don't even know where/how to begin responding to this one. First you want to argue that it makes sense for 15 years to 'earn' a measly 3.5-4% rate of return (by paying down the mortgage early) rather than potentially capturing 20% returns we've been experiencing in this historical bull market, and then you want to suggest that when the mortgage is paid off, you might possibly invest in the market? Seems to be a hypocritical argument to me, but perhaps I'm missing your point. The bottom line is this--a home mortgage is one of the cheapest loans you're ever going to receive. Take advantage of the opportunity to acquire cheap, leveraged money to finance the house, and use available capital to invest in the market. I currently have a car note at 2.9%. While it'd be nice to pay it off and have no car payment, I'd much rather take that $40k that I owe on the car and invest it--exact same principle. I think a lot of people either don't understand (or are afraid of the uncertainty) of leveraged finances and TVM.<hts>

<Steve> There are plenty of other factors, but I think what I originally said is true, that it makes sense for anyone able to do so and comfortably afford a refi from a 30 to a 15 year note to do that. Assuming the 30 is not already substantially paid down and the refi is for only the principle amount (no cash out).<Steve>

<hts> I disagree. It absolutely does *NOT* make sense for anyone to refi from a longer note to a shorter one for the following reason:

1. Why obligate yourself to having to pay more each month if you don't have to? There's nothing stopping you from paying off a 30 year note in 15 years (or 20 or 10). You can make additional principal payments at any time you choose which will have the same net effect of paying down the mortgage balance and reducing the total amount of interest paid.<hts>

I'm sure that my responses won't sway you at all, but at least you won't be able to suggest that I failed to respond to your points.

[riaelise]

Originally Posted by austin-steve

Sending extra payments isn't as good because the interest rate is still higher, and few people have the discipline to methodically send extra payments.

Also, I've clearly predicated the "15 year can be better for most" on the assumption that the 15 year note payment is affordable for the particular borrower.



I offered specific rebuttal to your rationale. You haven't responded specifically but instead offered insults based on your assumption that you're a superior thinker and I'm some sort of financial idiot. All while clinging to the ridiculous notion that the stock market offers risk free return of 9% that can be relied upon. By the way, 3-4% risk-free return (not sure how you came up with that but will go with it to make the point) is better than anything available on the market today in CDs or otherwise, so it's a perfectly reasonable alternative.

Every property I own is now on a 15 year note. The only ones I didn't refi are the ones close to free and clear already. I practice what I preach. I'm 51 and in 5 years my wife and I can quit working the rest of our lives and never run out of money, so I'm quite happy with my financial decisions.

If you can achieve good results your way, and achieve financial freedom, go ahead. But don't tell me you can explain something but not understand it for me, while not responding to the obvious holes in your arguments.

Steve

The money we saved with the refi ended up being returned to the lender in the form of extra payments. You're right that many do not do this, but that's their choice. Sure 15 yr mortgages are a faster track to paying off a house but for many people that is not an option. The extra money can be burdensome and isn't as small as you're making it out to be. 400 per month isn't that small. In our case, our payment would have jumped to over 3000 per month. While we can afford that now, we'd much rather pay far less and keep the cash. We're not moving anywhere. Paying extra allows us to lower the mortgage but if anything catastrophic happens, we would never be in the red. We will achieve debt free status hopefully at 60. Buying young I feel was very advantageous.

[verybadgnome]

I think having a 15 year note effectively disciplines the borrower from throwing away money elsewhere. In this consumer-oriented society most people will not end up paying down the principle as keeping up with the Jones' and shiny objects hold too much allure. I was also able to dump escrow by refing to a 15 year and go down two percentage points. With a 15 year loan my retirement age will basically align with the time I pay off the mortgage.

I think 30 years is too long. In Canada the standard loan is 25.

[hts]

Originally Posted by verybadgnome

I think having a 15 year note effectively disciplines the borrower from throwing away money elsewhere. In this consumer-oriented society most people will not end up paying down the principle as keeping up with the Jones' and shiny objects hold too much allure. I was also able to dump escrow by refing to a 15 year and go down two percentage points. With a 15 year loan my retirement age will basically align with the time I pay off the mortgage.

I think 30 years is too long. In Canada the standard loan is 25.

Your point is well taken. A 15 year note does in fact impose forced discipline and can most certainly be a benefit to those that require it (then again, a 30 year note also imposes discipline).

My point is that most of us don't have unlimited access to capital. In other words, we're all tying to figure out the best balance of how to spend/save/invest with the limited income/resources we have. I am one of those guys that can't save/invest enough. If anyone is not familiar with the Rule of 72, it basically suggests that you can divide 72 by your average rate of return (let's just use 9% for this argument) and determine that it will take (approximately) 8 years for you to DOUBLE your investment (without having added to it).

Think about that for just one second. If you have $100k invested in an asset (index mutual fund for example) and don't touch it (don't add or subtract from it) for 8 years while the market averages (some years it may return more, some years less) then at the end of that 8 year period, you'll have $200k thanks to the power of compound interest.

I'm not a financial planner (although I do have an MBA, class of '97) and realize we're going off tangent here, but I obviously get quite emotional about topics such as these. I hate seeing people make mistakes just because they may be naieve or not fully understand that there may be other options available to them--sorry for my rants.