Why a Mortgage Could Be Your Best (and Worst) Move

Why a Mortgage Could Be Your Best (and Worst) Move

 

If mortgage debt is good debt, why are so many borrowers having such a hard time right now?

 

Financial experts often tout the virtues of home loans, arguing that mortgages are the cheapest money you will ever borrow.  Yet many homeowners are regretting the day they took out a big loan, and some are falling behind on their payments and even losing their homes to foreclosure.

 

Mortgages are a double-edged sword.  The leverage can magnify your gains — but it can also leave you in a nasty bind.

 

If you need to borrow, you will be hard-pressed to do better than a home loan.  Not only are interest rates typically low, but that interest is usually tax deductible.  To get a mortgage, you need to own a home or agree to buy one.  But once you have that debt, the effect is to leverage all your assets.  That can be highly profitable.

 

Suppose you have $300,000 in stocks and you want to buy a $300,000 home.  You could sell your stocks and pay cash for the house.  But you will likely fare better by putting, say, $100,000 of your stock money toward the house and funding the rest with a $200,000 mortgage.

 

Result: You control $500,000 of stocks and real estate, 40% of which was bought with borrowed money.  As long as your assets generate higher returns than your mortgage rate, the leverage is working in your favor.

 

Before you take out a hefty home loan, make absolutely sure you can handle the monthly payments.  If you end up with monthly payments you can't afford, things can unravel fast.

 

If you are in this predicament, it isn't a calamity, provided you can afford the monthly payments.  What if you can't?  This is one financial quagmire that's hard to escape.

 

If you have a fixed-rate mortgage, paying down principal won't lower your required monthly payments.  Instead, it will shorten the life of your loan, which won't help with your current cash crunch.

 

Try refinancing. By taking out a new 30-year mortgage, you could reduce your monthly payments, simply because you're re-extending your loan back over 30 years. If, at the same time, you can pay down a chunk of principal, that will help even more.

 

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