I don't get it! Why should you have a loan on a house???

Question

If I have a $150,000 loan on a $150,000 home, I will have paid over $300,000 in payments by the time it is paid off. Instead of saving over $150,000 in interest payments by just paying cash for the house, why does everyone still recommend having a loan?

Why does having debt and a horrible amount of interest to pay build equity?

Yeah, I can deduct interest on my income taxes, but so what? If I still owe twice as much as what the house is work in interest, what's a couple thousand in tax savings?

Wouldn't saving hundreds of thousands of dollars in interest payments be worth just paying in full for the house to begin with?

Can someone tell me why, in detail, or is it just Mortgage lenders who say that all this debt is good?

Answer 1

1) Most people don't have that kind of money lying around

2) Even if they did, most people want the most expensive house they can afford. Loans stretch what you can afford

3) (the intelligent reason) Leverage. If you've got $500,000, you can buy one $500,000 home, which will increase in value at the rate of about 5% per year. Or you can put $100,000 down and take a loan out at (say) 6% on the rest, while investing the $400,000 at perhaps 10%. After ten years, your house is worth $815,000 (about). If you invested the other $400,000 (hauling out a calculator), and made payments out of it, you still owe $334,000 - but you've got $591,000 in the bank, which leaves you with $257,000 more than you would have had. Or, let's say you've got income, and can rent the houses. You buy 5 $500,000 houses, borrowing $400,000 on each. After 10 years, each is worth $815,000, less the $334,000 you still owe, or your net is $481,000 per house, and almost five times more than your original investment in ten years is nothing to sneeze at! Multiply by 5, and you've made over $2.4 million with an initial $500,000 - which beats the stuffing out of $815,000 if you just bought the house outright.

Answer 2

Your question is a good oone and should probably be asked in an envirorment given to more lengthy and involved answers than you are likely to get here, but let's see if it can be answered so at least you are satisfied.

I am assuming (although not sure from the way you have asked your question) that you are not a millionaire with hundreds of thousands of dollars lying around doing nothing but earning a minscule amount of interest.

First, you are correct in seeing that over the course of a loan (mortgage) on a house (now usually in terms of 20 - 30 years) you are likely to pay more in interest than the loan itself. But let us take into mine few people have $150,000 readily available (cash) to make such a large purchase. And to make matters worse in the process of liquidating certain assets to raise such an amount, taxes (capital gains) will likely be incuured (the sale of long term investments) which, depending on the cost of the asset when it was purchased, can negate a sizable amount of what was supposed to be used.

In addition in an effiort to promote the construction and ownership of private homes, Congress allows for a certain deduction of the interest paid against a mortgage for those that itemize. Morever, a mortgage is usually, but not always the leat expensive (lowest interest rate) of any other consumer loan.

Oh, and something else. It is very unlikely a lender will grant a loan for the full value of the asset. More likely a "downpayment" will be required thus establishing some "equity" in the item you are purchasing of somewhere between 10-25%.

Now, what does taking out this loan do for you that paying the full pice does not. It frees up money that you would not have if you "paid in full". Otherwise to get at this money, you would have to take out a loan that would probably be at a higher interest rate than a mortgage.

Now the next thing a person has to determine is how he will use these extra monies. Say, the stock market is booming and he can double his money in 5 years, this would more than offset the cost of the mortgage. Or if he had children in college financing that expensive with free money would be much less expensive that taking out a loan.

Space here does not allow to adequately answer your question. You would well to go to themontleyfool.com as I am sure this topic can be found in more depth there.

Good Luck. And I hope other contribute here

Answer 3

It is in your best interest (money wise) to pay cash for a house. Although, by paying cash you will not help your credit at all. But, I don't know your situation but in mine I do not have an extra 150,000 to pay cash for a home either. So, Your only option is to borrow. If you want a great way to purchase a house do what I did. Go into the loan process with at least the 20% to put down. Then use extra money to buy down the rate of the loan(sometimes a extra 1,000 or 2 can drop your rate up to 1%). Lastly get a 30 year loan and by only paying one extra payment a year (13 payments annually) you turn your 30 year loan into a 22 year loan and save a bunch in interest. Also, with the thirty year loan if something comes up you will have a smaller payment if you have to pay the minimum.

Home buying and mortgaging has lots of scenarios and everyone is different I am just stating what I did and it has worked well for me. I hope you find the answer you are looking for and congrats on looking for a home.

Answer 4

Debt is not good. No one will tell you DEBT is good. CREDIT is good, and a mortgage helps establish good credit, but if you are able to do that iwthout mortgages (and you absolutely can) then do so.

The Key is that very few people have cash to pay for their homes. They MUST take loans. Heck, most dont even have DOWN PAYMENTS.

Also, FYI, you do not "Owe twice as much as the house is worth in interest". Interst accrues throughout the life of the loan, not at the point of purchse. If it is a fully amoortizing loan, like most, you never owe MORE than the purchase price-- your principal balance goes down each month.

Some people think that if you deduct $5,000 in interest on your taxes, you "get" $5,000 back. Not true. You get back the income taxes you paid on $5000 worth of your income. NOT the same thing at all.

If you are financially secure, go and pay in cash. However, if you had outstanding credit cards and car payments, it would make sense to pay those off and use the remaining as a down payment on your home-- a lower APR than most CC's or auto loans.

Answer 5

Paying for the house up front would be the best option. But, the great majority of people cannot afford to pay for a house up front. The point of a loan is to space the payments out over a 15 to 30 year period so you are able to afford the house.

There is no "recommendation" from banks or mortgage lenders to get a loan, it is the only way for the vast majority of people to purchase a house.

Even people who are wealthy enough to purchase a house out right do not often do so. That is because if you spread out the payments over a span of years, you can afford a larger/nicer house.

Equity is built up in a house by paying down the principle (the original value of the home) and by the increasing value of the home. For example, you pay more than your minimum mortgage payment and pay down $5,000 on the principal in two years. In that two years, your house increases in market value by $5,000. In that case, you would have built about $10,000 in equity because that is how much you would "profit" to sell the house at that time.

Since most people cannot afford to completely pay off a house up front, the tax savings is an incentive intended to increase home ownership.

I believe debt is never good to have if you have the money to pay for everything out right. However, there is debt that is positive. For example, student loan debt that comes from getting a degree is positive. And home ownership can be positive debt as long as you are living within your means and not signing up for a high risk loan.

Answer 6

Leverage? Is paying cash the best use of your money? With a 15 year mortgage, you'll pay less interest over the life of your loan. I would at least put 20% down to eliminate PMI. Trouble is, you'll come close to not making the minimum amount for tax purposes, unless you have medical expenses or donate often. Can't you use the money elsewhere? If not and you have money to spare, pay cash.

If you can make more than the interest rate plus the rate of inflation investing the money elsewhere, invest. For example - 5% mortgage + 3 % inflation - if you can make over 8% somewhere else, take the mortgage. Of course, you get the interest deduction on your taxes, but I would take the standard deduction if I could and not have a mortgage to worry about.

Consult your tax advisor and financial advisor for more details.

Answer 7

Depends. What is the interest rate on your mortgage loan? 6%? What could you earn if you invested that $150,000 instead of paying cash for the house? 8%?

Looks like you're throwing away money if you pay cash for a house instead getting a low interest rate loan and invest the money...

Yes, I'm a loan officer, but the logic still applies...

Rick
www.homepropertysolutions.com

Answer 8

If you don't have the cash to pay for the house, then the loan is your only option. Some people who do have the cash, think the interest write-off and/or the return on money that they invest elsewhere, will be more substantial that the cost of the loan.

Answer 9

If you have the money of course anyone would pay it off also not just anyone can qualify to get those kinds of loans in the first place you have to meet all kinds of requirements just to get approved for a home loan. And whos to complain would you lend someone that much money if not then live with interest its what makes the world go round.

Answer 10

Obviously, if you have the money, it does not make too much sense to borrow money.

In theory, you can borrow money against a house at a lower rate than a personal loan, car loan, or another other type of loan. In addition, as you mentioned, you can deduct the interest payments from your taxes.