Musings Of An Indie WriterFriday, January 5, 2007
The Folly Of A Home Mortgage For A Young Couple
Ever since your Curmudgeon penned the first Sturdy Wisdom essay, various persons, most of them fairly bright, have written to upbraid him about condemning the home mortgage. Why, everybody knows a mortgage is the only way to buy a house, and a house is the only remaining significant middle-class tax shelter! EVERYBODY KNOWS THAT!
What "everybody knows" is usually wrong -- and this is no exception.
Consider all the following:
- A typical modest middle-class house, outside the coastal population centers, costs in the neighborhood of $250,000.
- A typical 30-year mortgage sells for about 7% annual interest, compounded monthly, apart from any application fees or "points."
- Such a house eats money in many ways, but let's limit ourselves to the truly inevitable: mortgage principal, mortgage interest, and property taxes.
- Property taxes outside the coastal population centers average about 1.5% of market value.
- Money spent on real estate is unavailable for other duties.
- The average first-time homebuying couple averages only 7 years in residence in that house.
- Except for anomalous periods such as the early 1980s and the early 2000s, real estate prices track inflation. In other words, real estate doesn't actually appreciate in real terms.
To avoid morgage insurance, the buyers will have to put down 20% of the purchase price at closing. This leaves them with $200,000 to mortgage. On a 30-year, 7% mortgage, their monthly payment, apart from property taxes, would be $1330.60. Property taxes would add another $312.50 to that payment, for a monthly "nut," all other considerations excluded, of $1643.10.
Here's what happens over 7 years of those mortgage payments:
| Payment | Amount Owed | Payment Equity | Payment Interest | Accumulated Interest |
| 12 | 197968.38 | 174.77 | 1155.84 | 13935.64 |
| 24 | 195789.89 | 187.40 | 1143.20 | 27724.41 |
| 36 | 193453.93 | 200.95 | 1129.65 | 41355.71 |
| 48 | 190949.09 | 215.48 | 1115.13 | 54818.13 |
| 60 | 188263.18 | 231.06 | 1099.55 | 68099.48 |
| 72 | 185383.10 | 247.76 | 1082.85 | 81186.66 |
| 84 | 182294.83 | 265.67 | 1064.94 | 94065.65 |
The debt has been defrayed by less than $18,000.00, at a cost of $94,000 in interest and $26,250 in property taxes. If we assume that the purchasers are in the 33% tax bracket, they'll recoup approximately $40,000 of their interest and property tax payments in income tax refunds. That leaves them with a net loss on their "investment" of about $62,000, assuming they can sell the house for the price they paid for it. But still, there is that $18,000 in equity...
Since we're discussing first-timers here, the comparison should be to a one- or two-bedroom apartment in a middling area. A glance at last week's Poughkeepsie Journal, the main daily newspaper of Dutchess County, NY, indicates that two-bedroom apartments in nice areas are available for approximately $1000 per month. So residence in such an apartment would cost the young couple $643 less per month than the house they considered buying.
Today, one can easily get 5% interest from a money-market account -- and without tying up the monies put there. So if our protagonists were to save the difference at 5%:
| At Year | Amount Saved |
| 1 | 7895.30 |
| 2 | 16194.55 |
| 3 | 24918.39 |
| 4 | 34088.57 |
| 5 | 43727.91 |
| 6 | 53860.42 |
| 7 | 64511.32 |
That's $64,000 cash in hand, compared to the $18,000 "equity" they'd have accumulated in the house they didn't buy. Nor have we considered the "operating expenses" on a single-family home: building and yard maintenance, homeowners' insurance, the price of oil and gas, and other incidentals that raise the actual cost of home ownership to a surprising degree.
But what if our heroes are utter exceptions to all the rules? What if they stay the full, 30-year course all the way to unencumbered title? Why, then they'll have spent a grand total of $529,000 buying their house, plus another $112,500 to the property tax authorities -- and it will still be worth only $250,000 in real terms.
In short, a house must be regarded as a consumption expense, not an investment. For young persons overwhelmingly likely to need (or want) to move within a decade of the purchase, it's a particularly bad deal.
In other words: Do the BLEEP!ing math before arguing money with your Curmudgeon.
