Buying a home is one of the biggest purchases of your life – you should be smart about it.
March 28, 2019
You may have heard that “owning a home is investing in your future” or “mortgage payments are a forced savings plan.” In fact, owning a home presents a great opportunity to an individual to manage their debt just as they manage other investments. However, owning a home involves more than simply taking a 30-year fixed rate loan and then sitting back waiting for market appreciation as you pay down your loan balance. Managing your debt like you manage your stock portfolio can save you thousands of dollars over the life of your mortgage.
Debts are as important as assets.
Most people strongly believe that in building wealth and maximizing net worth, debts are as important as assets. For most of us, the biggest portion of debt on our personal balance sheet is our home mortgage. To wisely manage this debt, we should monitor our loans closely to minimize interest costs and maximize our net worth.
To analyze your mortgage like an investment consider the following:
- The Hold Period (i.e. how long you plan to be in the home or with the loan)
- Your Future Interest Rate Assumptions
- Interest Costs vs. Nominal Payments
- Present Value vs. the Future Value of Money
- Return on Other Investments
With all the new loan products available, one of the most important factors in deciding which loan product to choose is your hold period. Even a one year change in how long you plan to be in the home or with the loan can cause a dramatic shift in the overall analysis. Match your expected stay with the fixed period that you select for your loan as closely as you can. This is particularly easy with today’s hybrid loans that give you choices of 3-, 5-, 7-, and 10-year fixed rates then converting to Adjustable Rate Mortgages (ARMs). All of these loans are still amortized over 30 years so you needn’t worry that the payments can be higher than a standard 30-year fixed loan.
The longer the fixed rate term on your loan, the higher the interest rate may be. A 5-year fixed to ARM will may have a lower initial start rate than a 30-year fixed rate loan. If you only plan to own your home for 3 to 5 years, then you may not want to pay the higher interest rates of a 30-year loan.
Would you invest $200,000 in a 30-year fixed asset and never monitor the market again?
Of course not. Then why do many people start their search for a loan by deciding that a 30-year fixed rate is the best product for them? In fact, many people overpay on in their mortgage interest by staying with a longer fixed period than is appropriate in their situation.
Why not consider a shorter fixed length and focus more attention on your single largest asset, your home. By devoting a small amount of time to managing your home mortgage, the benefits can outweigh the time invested. Especially because today’s refinance process is becoming simpler and the process of securing the right loan has never been easier with digital mortgage services.
Future Interest Rate Assumption
Your personal expectation for the future of interest rates is an important factor to consider when choosing a mortgage loan. If you feel that interest rates are going to skyrocket, then you’d certainly want some sort of fixed rate. If you believe that interest rates will remain relatively stable, the savings of an Adjustable Rate Mortgage (ARM) might be more attractive. Uncertainty about interest rates causes borrowers to make decisions along risk comfort levels.
Only you can decide which loan feels right to you, and you should not let a broker or agent dissuade you from what is most comfortable for your risk profile.
Interest Cost Versus Nominal Payments
Monthly (nominal) mortgage payments include an interest payment and a payment towards the reduction of the loan’s principal balance. Any loan analysis that simply adds up payments will become increasingly skewed over time due to this principal reduction. For example, a 15-year fixed rate loan may have a higher monthly payment since you are paying off the loan over a shorter period of time. However, the loan’s total interest costs may be substantially lower.
Present Value Assumption
If you had the choice of receiving a dollar today or a dollar in 30 years, you would probably take the $1 today. In other words, a dollar paid in 30 years is clearly worth less than a dollar paid today. When comparing various mortgage payments on different loan options, it isn’t enough to simply add up all the payments over the total number of years. If you did use a simple addition formula, and then compared two different payment totals, you would be ignoring when the payments are being made on the different loans. By doing so, you would probably be lead to the wrong conclusion.
A discounted present value analysis, while it may sound complex, simply allows you to add up all the payments of two totally different loan products with different payment schedules while considering the time value of money.
Return on Other Investments
Finally in analyzing your mortgage, don’t ignore the opportunity costs of not having cash in your other investments. If you are able to invest your cash in ways that produces higher returns than your interest expense of your mortgage, it may make sense to take a shorter fixed loan and invest rather than paying more on a 30-year fixed mortgage.
Goodmortgage can analyze a borrower’s information to recommend mortgage loans based on the above criteria. This is an easy way to keep your mortgage choice consistent with your other investment decisions. Some of the factors like interest costs, present value assumptions, and tax deductibility are built into the program. Other factors are determined by user input.
In summary, it pays to monitor your loan and treat it as seriously as you do your assets. Since most people have mortgage balances that are substantially greater than their portfolio of assets, the limited time spent in monitoring will reap major benefits. Times have changed and the choices for mortgage loans have grown, so there’s probably a product available that you never even considered.
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