To Mortgage or not

[BOB W]

It appears that people have been remortgaging their homes over the last several years to get equity out of their homes to accomplish other objectives in their lives. There are pro and cons to this behavior that vary depending on the overall financial condition of the indivdual.

In the interest of continuing non-tax discussions, but client related issues that come up in our practices, like financial planning and general investment issues, I would like to discuss mortgages and there pro and cons. (I say General Investments issues because unless someone is a registered rep, one should not be getting involved any deeper than "generally".)

I'm in favor of having NO mortgage because having a mortgage quarantees one will pay back 1 1/2 to 3 times the amount of the original mortgage. Some say " I can do better investing my money and keeping my mortgage". As seen from 1999 to today, that logic can be very costly. Now they have a mortgage and a lot less liquity.

What do you think???

[S T]

Mortgage, Refinance, or NO

Bob, that is a very good question. However, I don't know that we can ever really convince our clients to be DEBT FREE!

I have clients that I counsel and suggest not to refinance, because every time they do, it is like "purchasing" their own home all over again. The points, the appraisals, and other escrow costs which I have seen total $7,000-$10,000. This is not including extending the term of the mortage again, like refinancing a 30 year loan paid down to 27 and then going back to a 30 year, in addition to sometimes increasing the amount financed.

The clients comment is "well I lowered my interest rate from 6% to 5.75%, and I saved another $65 per month", plus I received cash of $20,000 to $??? So I say, you will be paying that $65 per month for another additonal 3 years or whatever, your costs of refinancing just were added to your mortgage, and now I say you have less mortgage interest to deduct on your tax return, so that is going to cost you about $20 per month in tax dollars for Federal and State, so your net is $45 per month savings, but you just extended 3 more years again, plus increased your debt. And oh the car you just bought, you will trade or sell probably in about 2.5 years, right???

Some if not most clients just don't get it! They want to buy the new SUV, take a vacation, pay off their credit card debt, then reincurr the debt again, etc. and then they say, that's okay I am going to sell this house in a couple of years. So now I say, Well how much net profit are you really going to receive, you have pulled out 80% of your equity and the remaining 20% if it is there, will pay the realtor commissions, and escrow closing costs.

I wonder what is going to happen to the real estate market and values, particularly here in Calif. I see some of the early 1990's happening again with all of the refinances and creative financing, like interest only loans due in 3 or 5 years., and maybe those values on the real estate won't be available, they might be 20% less, in which case some of these clients will have no equity!

Sandy

[Snaggletooth]

Behavior takes priority

Bob, you bring up a very good issue. Debt seems to be directly proportional to a given person's spending habits no matter how well-endowed or poorly-endowed they might be.

For those of you not around in 1986 - ALL personal interest before then was deductible on Schedule A - credit cards, auto loans, boats, etc. The '86 code then changed such that only home mortgages were deductible. At that point, banks began marketing "home equity loans" with higher fees and higher interest rates. The idea was that a $20,000 car note could be converted to a "second mortgage" and thus the interest on the car could be changed from non-deductible to deductible.

In 1986, I had a customer who consistently spent money on foolish, unnecessary things and his wife was even worse. I went through good years and bad years with them, and they always managed to spend more than they made. Their credit card accounts were horrendous, totalling over $50,000 (which would translate into double that amount in today's $). And they were unsecured. However, these folks had $50,000 equity in their house.

That year, it was necessary that I have the obvious conversation with them. It was a no-brainer -- this ridiculous debt would be converted to a second mortgage, and interest on the money would thus remain deductible. However, they were in their late 50s, had professional jobs, and should have adjusted their lifestyle long before then. Their course of action was very obvious - the switch could be done without incurring any more debt.

The next year, they were proud to give me two 1098s, and thanked me profusely for the sound advice. They had their second mortgage and had paid off ALL their credit card debt.
But guess what? After their credit cards were paid off, they began ringing up debt all over again. Their tax return showed lots of home mortgage interest, over $100,000 in salaries (in 1987 dollars), and ZERO interest or other investment income. A fresh $50,000 in credit card debt replaced the amount paid off.

These customers told me they had a "very good year."

You cannot negotiate with stupidity, folks. Bob W, you are quite right, we have opportunities to discuss these and other financial matters with clients that are NOT tax-related, and personal finance presents us with outstanding opportunities to be helpful outside the scope of the 1040. We must all understand that human behavior is the ace of spades that can trump any sound advice we give them. In my opinion, this is why we cannot be associated with RALs, and promote financial idiocy amongst our clients and negate all the good advice we try to spread.

[BOB W]

Debt Free

I agree that most clients will never reach a debt-free financial condition. But there are some that have the opportunity to do so but never think of setting it as goal to acheive prior to retirement. No matter the age of the client, I always push home the concept of maintaining debt free status, it just makes sense. They may not achieve that goal, but I'm sure they will not be as "in debt" with that goal.

I recently had a newly married couple email me about putting $2,000 into an IRA. She makes $70,000 and he makes $40,000. She said that she was able to save that much this year. Her monthly overhead was about $3,000. I explained to her that she should be saving at least $25,000 per year on their salaries. I also told her that if she was going to have children she would need that financial cushion during and after the birth of her child(ren). She was shocked to realize how much they were spending for entertainment and eating out. I believe I shook them up pretty bad and brought them to the door step of reality and the need to plan ahead.

[Lion]

Mortgages

Some of my clients want to have some credit available during their retirements to deal with the normal cycles of home repairs, health, etc., and find they have difficulty opening up new credit after their regular paychecks end. They should've put something -- a home equity loan, an unused credit card -- in place before they retired to save for a post-retirement rainy day. Others pay off their mortgages on the advice of a financial advisor or a friend or their grown children who hope to inherit debt-free and then are surprised at how much more they're paying on 15 April. They're mad at me but never asked me the tax implications of what they were going to do, so we couldn't adjust withholding or increase estimated payments in time. They wanted no monthly mortgage bills but didn't plan for the 15 April tax bill AND the 15 April estimated tax bill -- weren't prepared emotionally or financially, didn't save enough to pay their taxes ("But, my financial advisor told me to put it in these investments; and now I can't get it out in time without penalties!). Maybe they postponed some charitable contributions until this year in order to pay off their mortgage last year, and now think it's unfair that itemizing will not save them money over the standard deduction. There's more than just the tax reasons for having a mortgage (or two). I try to get my clients to tell me when they're considering a financial step, so we can plan accordingly. But, so many tell me after the fact.

[BOB W]

Too late for some...

... I know the type. There is nothing you or me can do for these clients- they are just tax return clients and that is that. Lack of planning is just their way of life or they have American Express as their financial advisor.

[Bjorn]

Debt Free

I often suggest not paying ahead on a loan, but rather invest that money to something more liquid such as mutuals funds, VAs, or something similar.

If I truly believed that, it would follow that equity could be pulled out of the home to be invested at a better rate than being paid.

Certainly it comes down to the client and if they can handle the debt service, cash flow, and other issues.

Personally, I suggest pay the minimum on low interest tax deductible debt and put the "extra" in investments. In my case I put everything in the Investment Company of America and let the money managers do their thing.

[BOB W]

Take on the mortgage.........

.....and invest the rest...... for some well disiplined individuals who are also market savy, it could work if they are young enough. 1999-2003 proved that even money managers don't have all the answers and that the indivdual must be and stay in control of their asset.

Most average clients are in an overall 30%ish Fed& St tax bracket. For each $1,000 of mortgage interest paid they will save $300 in income taxes. If they didn't have a mortgage they would pay $300 in taxes but they will save the $700 they were paying to the mortgage holder. To me that is a good savings...............