Mortgages are a Scam – Buying vs Mortgage

Mesa Verde 2021

Well, I think that will take the cake for the most clickbaity title to date. Now maybe the word scam is a bit too harsh and doesn’t apply in all circumstances, but I thought it was catchy for a post. This week I thought we’d talk about some of my thoughts on mortgages. Along the way, I will try to avoid the well-tread area of the rent vs buy debate. I liked this post from Route To Retire if you want to see some of the points in that debate. Instead, I want to give my opinion on when you should buy in cash versus using a mortgage. Frankly, I wouldn’t have much to add to that discussion at this current time anyway.

Disclaimers

So I’m going to attach a few rather large asterisks to the claim I’m making here. I think mortgages are great for some people compared to others. I think there are cases when it makes sense to buy in cash too. It depends on your current and near-future needs.

I also think that buying a house is a personal decision. While there is a financial depth to the decision to buy a house or not, that shouldn’t be the only reason to buy or in some cases not buy. Why I would or would not buy a house could be, and probably are, different from the reasons you might.

Advantages of the Death Pledge

Mortgage translates to death pledge. I discovered this during my research and thought it was interesting. I just couldn’t find a way to work that into this post anywhere else.

So real quickly let’s go over the advantages of a mortgage. Namely, lowering the initial bar for entry, forced savings, and investing the difference.

In my opinion, the most beneficial advantage of a mortgage is that it lowers the bar for entry. This allows people who wouldn’t otherwise be able to buy one in cash to, well, buy a house. I think this is a net positive for everyone, having the option to finance a house when saving a large sum of money may be the difference that allows some individuals to buy.

Playing off of that, another advantage of a mortgage is that it forces people to save. Putting a fixed amount into your house every month means that you’ve saved some portion of your income even if you spend the rest. Since Americans are, on average, garbage when it comes to saving their income I think some form of forced savings is helpful.

You can also invest the difference. Shifting from the advantages of saving and helping people to save more money to people who already have enough cash to buy a house, you can buy a house at a lower interest rate than the anticipated market returns from investments and then invest the difference. If this proves to be true, by the time the mortgage is paid off, assuming the house did not depreciate over that period, you’ll have made an additional profit.

Disadvantages of the mortgage

While we’re discussing the death pledge, we still have to consider the disadvantages of it. In this case: interest, and higher fixed cost.

As a mortgage is a loan, there will be interest to pay it back. In today’s environment where mortgages are around 6-7%, that’s a significant amount of interest to pay back over the life of the loan. But even at 3% that’s still a significant sum of money. As a counter to the above, you could invest 3% more a year if you bought outright and instead saved that money. Plus all else being equal, that interest payment is just gone.

As it’s a loan, a mortgage also increases the amount of debt you have and will have to pay back. If you just make the minimum payments on the mortgage, you’ll have higher fixed costs over the life of the loan than you would have had you bought the house outright. Lowering your fixed expenses frees up the money you do have to allow you to put it towards the things you want. This is especially felt during retirement.

Advantages of Buying in Cash

With a short discussion on some of the upsides and downsides of a mortgage, we should do the same with buying in cash. Overall, I see the following advantages: lower fixed expenses and lower overall costs.

Owning your house outright means that you’ll have a lower fixed cost. That pesky mortgage will be gone, meaning your fixed cost for every month. Sure you’ll still have maintenance costs and all the other expenses that come with owning a home. But you’ll have gotten rid of one, usually rather significant expense that comes with homeownership.

On top of that, you’ll have a lower overall cost. With a 30-year mortgage at 3% interest, you’ll pay quite a bit more than you would be paying outright. Looking just at the amount of interest you’ll pay, taking a 30-year mortgage on a $200,000 house with 10% down at 3% interest you’ll pay a total of $93,000 in interest for a total cost of $293,000. Approximately one-third of your loan payback over that time will just be interest payments, that’s a large sum of money on top of the cost of the house and other fees you’ll have to pay. That would equate to an extra $3,000 a year for those thirty years that could be saved or invested.

Disadvantages of Buying Outright

Of course just because there is some money and monthly savings for buying a house doesn’t mean there aren’t still disadvantages. Namely, the time value of money, leveraged returns, and it has worse returns than an investment.

The most obvious one is that buying outright doesn’t let you take advantage of the fact that a dollar tomorrow is worth less than a dollar today. With a mortgage, the amount you’re paying back could be lower after adjusting for inflation compared to what you initially took out. In that case, you’ve saved money down the line.

Much like mentioned above, with a mortgage you can invest the extra money you would have spent on the house. Depending on your mortgage’s interest rate, you could end up with more money at the end of it all.

Speaking of having more money, you also could take advantage of leveraged returns. While I don’t like the idea of a primary house being an investment, you can do so. To vastly oversimplify the whole thing, say I buy a house for $200,000 with 20% down with a 0% interest mortgage. A year later I sold it for $220,000 after fees, taxes, and anything else. I would walk away with a profit of $20,000 or about 50% thanks to the leverage even though the house just had to appreciate by 10% a year. Granted this example excludes fees, taxes, interest, inflation, and everything else. I think the usual suggested holding period is at least 5 years.

When to go with the Death Pledge

Now that we’ve gone over some of the pros and cons, let’s take a look at which option is “better.” In short, it depends on your work status. We’ll start with when you may want to take out a mortgage. 

I think a mortgage makes sense if you’re not on a fixed income of some kind. So essentially if you’re still working. If you’re having that income from a job of some kind, it makes sense to take the mortgage so that you can invest the extra money for the long term rather than putting it aside in short-term investments (CDs, bonds, etc.) and instead put it into stocks. I like this approach since you don’t have a fixed income when you’re working, you can always take on another job or get a raise. Over time, the mortgage makes up a smaller percentage of your expenses compared to owning outright.

You want to lean into the advantages of the mortgage. If you’re a saver, you can invest the extra amounts that you would have had to set aside to save for the mortgage. If we ever get rock-bottom mortgage rates like we had during 2021 I’d be more interested in getting one even if I’m retired.

Now there’s also the question of timing. I’ve been assuming throughout this post that you have the cash sitting aside to just buy a house, for most people even high-net-worth individuals, that’s not usually the case. Furthermore, you could find a place that’s good for you and that you’d prefer to live in even if you don’t have the cash, you could take out the mortgage to buy it instead of hoping it stays or comes back on the market down the road when you have the cash. After all, there are more things to consider than just am I in a fixed income situation.

When to buy with cash

Shifting to cash, there’s a very similar situation that I see buying with cash as an advantage. Mainly it’s if you’re on a fixed income.

If you’re retired (FIRE or traditional), you tend to have less or closer to a fixed income. For instance, when I hit FIRE, I plan to have up to $4,000 a month in cash to spend every month. With a mortgage, I could be eating up a significant amount of that money, approximately $2,000 a month at the price point I’m currently looking at. If I work for a few extra years or save some of that $4,000 after retirement until I can buy in cash.

With that money, I can then buy outright and not have that monthly expense of a mortgage hanging over my head, freeing up that cash for other uses.

Other considerations

Now, this just looks at the money side of things and my opinions on that.

But there’s more to consider when looking to buy a house. Such as timing, how much you like it, and a bunch of other factors. You shouldn’t fully sacrifice these considerations when considering buying.

Also, adjustable-rate mortgages are a worse idea and require much more consideration. I would not suggest these ever. From my research, they’re significantly harder to refinance.

Wrapping up

So here are some of my thoughts on mortgages versus buying outright. It comes down to not having that fixed expense when you retire so that you can free up that cash to cover your other expenses, whatever those may be. As for me, someone who plans to retire back to New Mexico, I currently plan to buy in cash rather than take out a mortgage. If I still worked in New Mexico (or if I take a job back home in the future), I might be more inclined to get a mortgage.

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