A BIT OF FINANCIAL APOSTASY: USE LOWER RATES TO SAVE MONEY RATHER THAN BUY MORE HOUSE

5/19/13

While working out this morning, I heard an ad for a mortgage broker on WBBM AM, Chicago’s news radio station, that went something like this. (Since I don’t have a photographic memory and can’t write as quickly as a person can talk, I can’t quote the ad precisely.  Its words and numbers may be slightly different from the below, but only slightly, and the point is the same.):

If you have $1,350 to spend on your mortgage, at today’s 3.5% 30 year rate, you can support a mortgage of about $301,000.  But if you wait until rates go back to a more normal 6%, that $1,350 will support a mortgage of only about $225,000.  That’s $76,000 more home that you would be giving up.

While there will (would?) be more market adjustments to deal with when (if?) mortgage rates get to a more “normal” 6%, this is an interesting argument based on the application of some simple present value concepts and appears to be an effective way of selling one’s mortgage services, or at least of persuading people to borrow money.   After all, who, especially in America, where people seem to always want to spend more, even if they don’t have more, would want to leave $76,000 of house on the table?

But here’s another thought….

If you have $1,350 to spend on a mortgage, why not pass on the $301,000 loan you think you can afford and instead borrow $225,000 at 3.5% and buy a home selling for $76,000 less?  Your payment on such a loan would be about $1,010.   You could then take the $340 per month you save and invest it.   The result would be…

• You would still have a nice, more than adequate home.
• You will be building, or adding to, your nest egg.
• You will have more money for emergencies or just the all too frequent but expensive non-emergencies that come with home ownership; you therefore sleep better at night and are therefore probably more pleasant, sharper, and hence more effective at work and in your interpersonal relationships.
• If things don’t go according to plan, as is common in this economy, you will have both a lower mortgage payment to make and some savings on which to fall back.
• If everything goes according to plan but you don’t stay in the house thirty years, you will have built up a substantial sum of money to go toward the down payment, or outright purchase, of your next home.
• If everything does go according to plan, you stay in the home for 30 years, you religiously put the extra $1,010 away and don’t spend it, and can earn, say 5% on your money (a not at all unrealistic, perhaps even conservative, proposition; since this would be a 30 year effort and would involve the dollar cost averaging that inevitably accompanies monthly level payments, most of the money could be put into stocks), you would have about $840,000 set aside by the time the 30 year term is over.  If you could earn 7%, you’d have about $1,230,000 by the end of the 30 year period.   Taxes would reduce these numbers, unless you were able to invest in a tax deferred vehicle, but the numbers would still be considerable.

You win.   The country wins because you are saving money.   The only thing you give up is the ability to say that you live in a house that you can barely afford.

I realize such a suggestion amounts to apostasy in a country obsessed with spending and displaying (usually false) wealth.   But it would have made such perfect sense, and be such standard practice, only a generation or two ago that I wouldn’t have had to make the suggestion.