Why so many Americans feel trapped in their homes by their low-rate mortgages

CNBC ^ | 01 Aug 2023 | Jessica Dickler

[Drew68]

Certainly not San Diego.

San Diego is stunningly beautiful, and absent many of the dysfunctions of L.A. and San Francisco.

But it’s still in California and a decent suburban home goes for $1.25 million.

[smokingfrog]

Wow. You actually planned for your retirement, unlike a lot of people.

[powerset]

“To me, debt is danger. Savings is safety.”

It depends. If the interest rate on the debt is below the *actual* inflation rate, then debt can be an asset. You can buy something you need before its price goes up by more than the interest on that amount of debt.

Also, although savings used to be safety, given recent government trends, it’s becoming a target.

[coalminersson]

I like SD especially Oceanside, weather and many marines with conservative values. of course the state is a high tax shithole.

I like the carolinas.

If you check out Stevenson Wash you might like it. No income tax in WA and cross the bridge of the gods and shop in Oregon where there is no sales tax. On the Columbia River, beautiful.

[Alberta's Child]

There is a certain mentality that thinks debt is a financial strategy.

If you are careful and disciplined, it actually IS. Two aspects of personal finance that are rarely understood by people who aren't experts are diversification and liquidity. You may think debt is danger, but there's also a lot of risk in having your net worth tied up in a single asset in one location that generates no investment income and can't be easily liquidated in the event of an emergency.

Think of it this way ...

If you have a $300,000 mortgage with a 30-year term and an interest rate of 5%, your monthly mortgage payment would be about $1,610.

Paying that mortgage off in seven years requires a monthly payment of about $4,240. That's an extra $2,630 you are paying every month for seven years to pay that loan off. After seven years you have a home with no mortgage, while your extra payments may have been able to generate a better return than 5% if you did something else with the money. An S&P 500 Index Fund, for example, would have yielded an average annual return of around 9% for the seven years that ended on July 31st of this year.

And even if you invested in something much more conservative than that, you still would have reached the end of Year 7 with a lot of flexibility in your financial position. If you had stuck the extra $2,630 in the bank every month and earned an average interest rate of only 1%, you'd reach the end of Year 7 with a mortgage balance of less than $264,000 and more than $230,000 in the bank. Your margin of safety here is enormous compared to a scenario where you pay the mortgage down to $0. What happens if you lose your job after Year 7? Will you have sufficient cash reserves to carry you for a while, or will you be forced to sell your home just to pay your bills?

If you carry out this process after Year 7 -- and this is assuming an average return of only 1% on the money you are saving, mind you -- your cash balance will exceed the remaining balance on the mortgage before you get to the end of Year 8.

The key point to remember here is this: Once you pay down a loan you can't get that cash back very easily if you need it later, but if you build up cash in parallel to your loan payment process then you will maintain a high degree of liquidity in your assets.

[ro_dreaming]

My little piece of land in SE Texas (Houston metro area) goes for 600k. It’s 8 1/3 acres with a 2500 4 bed 2.5 bath (no garage) 1 story house.

Real estate everywhere is getting nuts.

[Svartalfiar]

The finance professor and his wife, Terri, purchased the 5,000-square-foot house with a pool nearly a decade ago. “It’s probably time to downsize,” he said. They would also like to be closer to their grandchildren in Tennessee. And yet, “we are in the 10th year of a 3.125% 15-year fixed mortgage,” he said. They don’t want to move now and give up that low rate to buy at a higher rate.

This guy's a finance professor? For real?

With those numbers, he's looking at having ~40% of the principle remaining. They could easily downsize to 2500 or 3000 sq ft and likely have the new home paid off from the sales proceeds, or close to it. So then who cares if you go from 2% up to 7%? With the new payment being half (or a tenth) of the old monthly payment (assuming they didn't pay it cash), they could probably pay off whatever's left in 2-3 years anyway.

[Svartalfiar]

Ideally, have a little debt a possible. We have none. Own outright. Own more if possible. But get out of debt. Stay out of debt. It's not the "DC" way, but it's the best advice possible.

Great advice for lower middle class folks, sure. But once you start having some decent money, debt and investing is how you make it bigger. If you can get a loan at 3%, then put money into investments that return 6-7%, why would you pay off the loan with the money? You're skipping out on 3-4% profit for the sake of 0% loss. There's a reason you hear about all these huge wealthy companies taking out loans for building stuff or whatnot. It's because they can make more money with that money than they lose on the low interest rate.

[Worldtraveler once upon a time]

--- "If you can get a loan at 3%, then put money into investments that return 6-7%, why would you pay off the loan with the money? You're skipping out on 3-4% profit for the sake of 0% loss. "

With respect, I see your argument for some politically connected multinationals, but have you such a low interest loan and high interest instrument paying you your differential each month?

[Svartalfiar]

With respect, I see your argument for some politically connected multinationals, but have you such a low interest loan and high interest instrument paying you your differential each month?

It's not a matter of political connection at all. It's just a matter of having the money available to invest it, as well as the time to do the research and do the investing. Or, even just having the money available to invest with some company. It's not that people take a loan out just for investing (although plenty certainly do), but my point was that when you have a mortgage at a low interest rate, it makes more sense financially to invest extra money in a higher-returning option than to pay off the mortgage earlier. Getting out of debt is good, but making money despite the debt is better.

And it doesn't take anything fancy - a quick search shows a simple option, the S&P500 index, has returned an average of 10% annually since it first started.