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Tuesday, October 16, 2007
Your Mortgage Is Your Friend
Until recently debt was considered something shameful and to be avoided at all costs. Given the growing levels of consumer debt the return of such an attitude would be a welcome thing. With one exception - mortgage debt.
Without mortgages few of us would ever be able to own the roof above our ahead. But beyond that obvious truth mortgage debt, being secured on a tangible asset, is usually much cheaper than other forms of personal debt such as loans, overdrafts and of course the dreaded credit card.
But the most powerful, and often overlooked, advantage of mortgages is the gearing effect that magnifies the benefits of rising real estate prices. Suppose you buy a house for $100,000, and in a year its price rises to $110,000. A 10% gain in a year isnt at all bad, and quite realistic with real estate. But suppose you only put $10,000 down and borrowed $90,000 from the bank. However much your asset increases you only pay back the original debt (plus interest). So in this case your original $10,000 would have DOUBLED to $20,000 after re-paying the initial loan.
We often scrimp and scrape to pay off our mortgage as soon as possible, but before doing so we should see if our money could be earning better returns elsewhere. For example, if you can get 8% on an investment, theres no point cashing it in to save the 5% youre paying on your mortgage.
Mortgage lending is competitive business and thats good news for borrowers. Dont sign up for the first deal you come across. Shop around, comparing rates and terms. One of the biggest decisions is between fixed and variable rates. This is a hard call as no one can predict whats going to happen even a few months ahead - not governments, not the best qualified economists - so dont believe anyone that says they can. Be guided by your own instinct, but be prepared to make a change if a better deal becomes available.
Be sure to read the small print. Often mortgages with the most attractive rates come with expensive up-front charges, exit charges, or both. Or there may be penalties for early repayment. These dont necessarily invalidate the benefits offered by the lower rates, but make sure you build them into your assessment. If the up-front charge is a fixed amount then its usually more beneficial the more you borrow - ie the savings will be more on bigger repayments.
Johnny Finnis is editor of personalmoneymanagement101.com, a simple and unbiased introduction to finance and investment for ordinary people to make the most of their money. Have your say on our blog
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