Posted on 10/01/2004 1:29:29 AM PDT by Las Vegas Dave
The wife and I are investigating LIBOR loans, and low interest loans. Our goal is to accelerate the equity to our home.
If you are familiar with such, please respond with positive/negative comments.
Any and all comments appreciated.
I believe that a LIBOR loan is just an adjustable rate mortgage based on the index known as the "London Interbank Offered Rate". It has the pluses and minuses of any adjustable rate mortgage. They are good for some people in some situations and bad for other people in other situations.
I suppose one question to be investigated is whether accelerating the equity on your home is a good idea. I think if it just makes you feel better or more secure then it is justified. But normally, it really doesn't make a lot of sense from a financial perspective.
Of course it is a good idea. Unless you are in the 101% tax bracket, there is no sense sending the bankers a paycheck every month when you could be investing the money.
Why? Pay out $5k in interest, use the deduction to save $1.9k in taxes....you're still out $3.1K.
In my opinion the only time a mortgage (that is not necessary) on a house really makes sense is if the equity is being used to invest in some vehicle where the ROI exceeds the cost of the money.
I've been in the mortgage business for almost 30 years. Financially unsophisticated people opt for a 15 or 30 year mortgage. They fear an adjustable rate mortgage (ARM) because future rates are unknown. Logical, but wrong.
The reality is there has been no time period over the past 30 years when you would have been financially better off with a 15 or 30 year fixed. Your total interest payments over any 3, 5 or 10 year period would have been less with an ARM. People pay a significant "premium" for the security of a fixed rate, fixed payment loan.
As for LIBOR, it's been at an historical low for the past couple of years, which is why it's become so popular. And many LIBOR ARMs are interest-only for 10 years, making the payment even lower (of course, you owe the same 10 years later as you owed on day one). It's very popular amongst folks who are more financially sophisticated since they understand fully the history of rates which I described above. The interest-only feature has become wildly popular this year, especially in high-cost markets where you can buy way more house than with "normal" mortgages.
Some LIBOR ARMs are known as "Option ARMs". The "option" is you get to decide each month whether you want to: 1) make a low payment that is the interest only for that month, 2) make a payment that is the interest owed, plus the amount of principal owed if you were amortizing the loan over 30 years, or 3) same as 2), but make the payment that would be owed on a 15 year mortgage (i.e., more principal). Is this what you are talking about when you say accelerate equity?
In reality, there are only two ways to accelerate equity: 1) make an additional principal payment each month, or 2) be fortunate enough to live someplace (like Las Vegas) where property values increase dramatically. If you do live in Vegas and think values are going to keep increasing, you might want to get an interest-only LIBOR loan and invest the difference. Otherwise, look at the Option ARM, which will allow you, at your option, to make smaller or larger payments each month.
If you have a fixed rate mortgage, regardless of accelerated pay down you payment doesnt change. So, if you prefer investing, instead of paying more on the mortgage to lower your balance, INVEST the money.
And a home is not an investment. It is a use asset.
I think people should pay off mortgages in what ever way fits their money management style. I don't think there is a right or wrong way. However, I have heard Edelman speak on this subject many times and he claims paying off a mortgage early is not necessarily the better way from a financial point of view. The money you are paying now needs to be measured against what it will be worth 20 years from now. Frankly, I'm not even sure I understand it fully but it has to do with giving the bank dollars today that will be worth a lot less in 15 or 20 years. If those extra dollars are invested instead of given to tbe bank you are supposedly better off.
Why accelerate the equity? You'll just lose the tax benefit faster. Keep a low interest 15 or 30 year mortgage, and put any extra money into a high quality bond fund. As interest rates rise, you'll do much better this way in the long run. There's nothing wrong with "owing money" on your home, when you've got the money on hand.
Here are the points to consider:
(1)What is the margin?
(2)What is the maximum adjustment allowed?
(3)What is the cap?
(4)What is the floor?
(5)How long will you be staying in the home?
(6)Where are you in the earnings curve ie upward sloping,
topping, downward sloping?
(7)Can you invest the difference between the adjustable
and the fixed (15 or 30) and get a return greater than
the fixed rate?
(8)Go to bobbrinker.com and find his weekend radio show.
He is an excellent source and a great sounding board.
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This is the part I don't go for. If you are paying $500/month ($6000/yr) in mtge interest the net tax benefit to you is, in most cases going to be $200/month ($2400/yr). You are still out of pocket $300/month ($3600/yr). Over the life of a 15 year mortgage that's $54,000 in interest payments for which there is zero tax benefit. The banks and the Feds both want you to owe, it funds the banks so they can make more loans to keep the money cycling. It's good for them, not for you.
You're missing the other half of the equation. If you have a mortgage of say $50,000 and can afford to pay off half of it right now, the question is, are you better off paying it off, or putting the $25,000 in another investment? If you keep the mortgage, you pay interest -- for now let's say 5% fixed -- but also get a tax break on that interest -- let's say 30%, so you're actually paying 3.5% interest on an after tax basis. Now if you take your spare $25,000 and put it in a high quality investment that currently does, or soon will provide an after tax return of over 3.5% (easy, given the certainty that interest rates will begin to rise soon), you end up ahead. Realistically, in the current interest rate environment, you can manage a significantly better return on the investment than you're spending to keep the additional mortgage balance outstanding, especially over the long run. Lock in the ultra low fixed rate now, and keep your spare cash in investments as the returns on those investments while interest rates go up. Once rates reach a point where you can lock in the arbitrage (say a 10 year CD paying 7%) it may make sense to do that).
Not missing anything. In an earlier post I wrote that the only time holding a mortgage that is unnecessary is if the equity is being used to generate a ROI greater than the cost of the money.
Holding and continuing to pay a mortgage unnecessarily in order to get the deduction is a sucker's play.
You seem to be contradicting yourself. It is virtually impossible that locking in a low mortgage rate now wouldn't enable the homeowner to earn a higher ROI on the invested money over time.
Tell that to those who hold LU or FON or any of a hundred other dogs, then ask them if they wish that they had paid off the mortgage instead.
And, as I said twice already, if you're keeping the mtge to get the tax "benefits" (paying out five to get two back) you're playing a sucker's game. But, you handle your money your way, I'll do the same, it's working for me so far.
I'm certainly not suggesting that people use individual stock selections as a way of investing money that could have been used to pay down a mortgage. But there are plenty of better alternatives -- in the current interest rate environment, CDs are a breakeven proposition at present, and sure to be a profitable proposition in the long run. And I'm quite sure there are people out there accelerating their mortgage payments, while failing to max out their contributions to tax-deferred retirement plans.
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Per Bankrate.com:
Thirty year fixed......5.37%
One year CD.......2.29% (taxable).
Not even close to break even. Since your earnings from a CD that is not in an IRA/401K type vehicle are taxed at the same rate as your income (against which you apply the mortgage deduction) you would have to find a CD that pays the same as your mortgage costs you to "break even". Banks make money by charging more for it than they pay so that's not about to happen.
Even if you start to look at triple tax frees you are not likely to find one that pays out a significantly higher rate than what your house money costs you.
Now, if you want to talk about tapping equity at six percent then leveraging it to buy rental rolls sufficient to service both debts you'd be starting to make sense.
My advice, get a 30 year fixed, and make thge minimum payments.
INVEST your extra money, and have the discipline not to spend it.
Then, when rates rise to 6, 8, 10, or 50% in future years, you will be glad that you weren't like the other suckers who paid off their loans early, since your payments will end up costing you far less.
You will also have the security of a nest egg that is there for an emergency. In know home equity can be borrowed in, but not if your market has crashed, or if you are out of work.
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