Wednesday, December 11, 2013

Mortgages Good Debt or Bad Debt?

There is only one kind of debt, bad debt. There are unavoidable debts, such as a medical debt. Mortgage debt may at times be the lesser of two evils, but it isn’t good debt. Wikipedia notes, “The word mortgage is a French Law term meaning "death pledge", meaning that the pledge ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure.” Gage, the pledge part, is related to the word for glove. Think handshake. Your mortgage is a cold dead hand resting on your shoulder. Isn’t that a cheerful thought?

We have been sold a bill of goods by our genetic makeup, as well as the real estate industry. There is something in young couples that tells them they have to have a home to call their own. I expect that was true in the days when my ancestors were crawling around in the caves of Western Europe. The real estate industry told us that prices can only go up. Of course that is nonsense. In 2006 we learned that in a finite world nothing can go up forever. It was a bitter lesson. In 1960 it was a given that your home near the big city would help fund your retirement in Florida. Those days are gone, probably forever.

Like all Americans, we wanted to buy a home when we were first married, but it wasn’t in the cards. Interest rates were running as high as 18% in those years. We were still working on getting our educations. The numbers just didn’t work.

Years later we were still living in an apartment after moving to a new city and starting a new life with new degrees and new jobs. One year “they” bumped our rent either 10% or 12% (I forget which) in one year. Rent for a two bedroom apartment exceeded the mortgage payment for a three bedroom house. I told myself, “If you want to ride the train, you have to jump onboard.” And I jumped.

Turns out I had intuitively applied a rule of thumb to the 1987 Maryland real estate market.

Always remember that rules of thumb only work thumb of time.

Take the annual cost of renting a property then multiply the result by 15. If the sale price of the property is greater, rent. If the sale price is less, buy.


Renting a three bedroom home in a certain city costs somewhere around $1,000 a month.
Hence $1,000 a month X 12 months in a year X 15years = $180,000
Therefore, if this home sells for less than $180,000, buy it.
If the home sells for more than $180,000 rent.

Of course there are other considerations. Not only do you need to calculate the rent/mortgage trade off, you also need to consider the additional costs of taxes, utilities, and home maintenance. My days as a home handyman are just about over. Like most men my age, I have problems with my knees and lower back. I take a heart medication that occasionally makes me a little dizzy. My wife won’t let me work on roofs or climb trees with a saw anymore. She is correct in her assessment of the situation. The last time I trimmed the big hedge in the front of our house I fell off my ladder and landed in the hedge. Fortunately, only my pride was wounded.

The big deal killer for most young couples is the down payment. For many years prior to the real estate bubble of 2000-2006 a 10% down payment was standard. This was tough for a young couple. We had to come up with $10,000 cash when buying our $100,000 home. There were additional closing costs, taxes, fees, inspection, and bills that totaled another $8,000. I had to borrow $3,000 from my father in law to rebuild what I would now call an emergency fund. In those days I just called it working capital. Today, a young couple needs to put 20% down to avoid the dreaded mortgage insurance. You pay to protect the bank. Isn’t that special? In the Washington D.C. area, that amounts to $60,000 cash for a typical $300,000 starter home.

Over the years, I have added one caveat to my mortgage decision lecture. Calculate affordability on the basis of one income, not two. Young couples often decide to start a family. When babies appear on the scene young women want to stay as close as possible to their children. Fulfilling this perfectly normal instinctual desire is good for both mother and child. At least give your wife the option to be a stay at home mom for a few years if that is her desire.

Do the math. Talk to experienced knowledgeable people who will not benefit from your decision. Say your prayers. If all the signals are a go, take a deep breath, and jump onboard.

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