Taking Liu's comments at face value as about the principles of mortgages in general, Jordan is also right, the post shows little knowledge of both leverage and the details of American financing.
On the leverage issue, we don't have to suppose that you put a minimal amount down on one house and put the rest into Amazon.com. I developed a spreadsheet on all this stuff and assumed that you could reinvest money at the rate at which you borrowed on the house. This is not hard to do with various bond funds. Taking into account all the tax implications (interest paid on the mortgage is deductible from income taxes in the U.S., which means that your real interest cost is determined by your marginal tax rate, which in most middle class cases will be about 35% state 'n' federal) and making the assumption that you have the wisdom to invest money received from the tax discount in some kind of investment, you come out ahead by staying in debt. That is:
Person A takes out a 15 year mortgage, pays off the house, and continues investing THE AMOUNT OF THE MORTGAGE PAYMENT for an additonal 15 years, with interest accrued at whatever rate is assumed for the mortgage.
Person B takes out a 3 year mortgage AND REFINANCES THREE TIMES INCLUDING MORTGAGE FEES, but is careful never to take out so much money as to require mortgage insurance. This OPTIMIZES the tax deduction, which is higher on the front end of the loan.
The time difference:
Person A will pay, say $1000 a month on a 15-year loan in the neighborhood of $100k.
Person B will pay about $750 a month on a 30 year loan of the same amount.
The tax difference:
In the first 10 years of the three successive loans real payments for Person B will be about $500/mo.
Because of the much lower total interest real payments for person A will be about $800 a month and the value of the tax deduction will decline on a steeper gradient.
Person B invests $300 a month (the difference between what his real payment and A's real payment) starting with the FIRST payment at a rate of interest equal to the mortgage. Person A invests $800 a month AFTER the 15 year mortgage is PAID off.
Results, if invested in taxable funds: Close, but person B wins by thousands of dollars. Results, if invested in tax sheltered retirmenent instruments: Not even close. Tens of thousands of dollars difference. At the end of thirty years person B, who has refinanced twice and is ten years into his third loan, can retire and PAY OFF THE HOUSE IN FULL and have tens of thousands left over, more, in fact, than person A, who has a paid-off house and 15 years of $800/mo invested against B's 30 years of $300 a month. (these numbers are not exact, but I don't have the spreadsheet on this computer).
But this is not all, folks. You don't NEED to pay those refinance costs. You can go into the 5/25 adjustable rate mortgages (five years fixed, and then floating to an adjustable rate) at about 1.5% LOWER than the fixed rate. MOREOVER, adjustables are set up so that you can get a new mortgage WITHOUT refinancing costs. If you did this you would make EVEN more money relative to A, assuming that there is not a permanent increase in interest rates which gives A an overwhelming advantage. In effect if you do this you opt for Canadian style finance which is entirely based on renewable five year mortgages. In this system, as in Australia, an effort is made to keep monthly payments the same and the term of the loan is adjusted to market conditions. It's an interesting idea.
In any case, having fully worked all this out, what do I observe: I don't have the chutzpah to float something as important as a mortgage payment. I'm working on a 30 year loan. I'm paying much of it off early in order to get to the 20% equity level as the mortgage insurance payment is a significant dead weight cost which alters the economics of the investment significantly.
Now, to the other point: is this a system designed for the rich? No. It is a system designed by banks. Its fundamental social effect is to promote suburbanization. It has a predictable result: it is actually cheaper and more cost effective to stay in debt than to be free of debt. You need only understand that your cost per month of staying in a house with a mortgage actually *rises* with each payment, since with each payment you buy more equity and pay less interest. At the beginning of the mortgage, a $1000 month payment nets out at $650. At the end, it nets out at $1000.
This system works to the advantage of the middle homeowning classes (66% of American families) and to the rich. It also works to the detriment of the poor, who pay mortgage costs and property taxes in their rent but who receive none of the benefit of the tax deductions. If there were a law which forced landlords to return the value of their mortgage interest deduction (say $3000 on $10000 paid over the course of a year) the suburbs would be, relatively speaking, much less attractive to people who want to leave off renting in the city and go buy a house.
There are secondary tax effects. Many personal business expenses (a computer or books or what have you) that you use for work purposes are tax deductible in theory but not in practice. That is because you must meet the 2% threshold: if your income is 50k, the first $1000 of "expenses" ARE NOT tax deductible, so if you spent $1,500 on supplies only $500 are deductible. But with mortgage expenses you *automatically* jump that threshold (You'd probably have $9 or $10 k in mortage interest alone, and property taxes are deductible on top of that, and then have buried the 2% requirement, you can throw in your business expenses).
What does this mean. Well, when my wife and I were saving for a house we lived in a great place in a crappy part of Troy (kinda place where booze bottles are on the sidewalk, the building next to us was leased by the county welfare agency) in a 2 bedroom, maybe 900 sq feet, for $650 a month which included heat and two parking spaces. In a good area we would have paid $850-900 a month and had to pay utilities on top. We are now in what the Times Union calls "an affluent suburb" on a 1/2 acre of gorgeous land and are paying, mortgage, taxes, and insurance, $1125 a month. We have double the interior space and much much more. The monthly cost factoring in tax deductions (NY state has *exceptionally* high property taxes, running about $4k year for the typical $120-130k house) is about $700 net of taxes. Adding in $150/mo miscenallenous maintenance (plumbing, bug killing, lawnmowers, what have you) and utilities at $150/mo, we net out at about $1000 a month, but of this, $110 is equity build up in the house. So the true cost is probably in the neighborhhood of $900 a month--exactly what you'd pay for a high end two bedroom apartment in this area, with considerably less space and considerably more crowded conditions.
In the end, how could it be otherwise? Urban landlords are paying mortgages just like the suburbanites. Become suburban and you capture the tax subsidy yourself, and build equity; stay a renter, and you cede that subsidy and the equity to a landlord. Live urban and take the deduction? Sure. But this gets into the very intricate question of a nation which funds its schools on the basis of a property tax. In essence, re-urbanization, high density housing, and all that, will be impossible without repeal or phase out of the tax deduction combined with moving the funding of all education to the income tax. Doing that will, however, probably negatively affect the asset position (home value) of tens of millions of homeowners who vote in much higher numbers than their urban counterparts. Probably won't happen. This is a core economic arrangment of our civilization and it won't change until some kind of transformational process completely alters the technologies we use and the ways we live.
How do I read this? As a structural assault on the city. It's just not worth it to live in an urban environment and the result has been that in this region the three main cities (Albany, Schenectady, Troy) have been eviscerated in the last 40 years. Population has increased 3% and devloped land area 80% since 1960. Albany has some urban life. Downtown Troy is basically shuttered, occupancy of ground-level retail type buildings is probably around 30-40% (my guess). Schenectady is on a par with Troy. In my first few years here I didn't even know what kind of environment I was in. I kept trying to live an urban existence. Now I see the reality: here, suburbia has won. The neat stuff, from movies to microbreweries, even cafes, are in the suburbs, in the malls. If you want to "enjoy the area" you have to opt in to the program for spatial segregation by income.
Whose interest does this serve? Take your pick:
Automobile industry Oil industry Banking industry Construction industry Insurance industry
In other words, it represents the core capitalist interests of the US in the 20th, and no doubt the 21st, centuries. And all this busy suburban consumerism of course leaves the heavy duty politics of procurement of raw materials to the CEO class and its politicians.
-- Gregory P. Nowell Associate Professor Department of Political Science, Milne 100 State University of New York 135 Western Ave. Albany, New York 12222
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