I’ve been thinking about mortgages and savings a bit more than usual lately, and with good reason. My father recently retired from his nearly 40-year career as a physician, and in trying to be a good son, I’ve been helping him prepare for the transition financially.
This involved taking an account of what he has saved up, his investments, and his expected cash flow. For him, the future that many of us scrimp and save for has come, and since he no longer works a day job, planning is all the more important.
Unfortunately, my father didn’t have the benefit of having resources like the White Coat Investor, Physician on Fire, or the Fire Your Financial Advisor Course. In fact, though he would have benefited greatly from having one, he never even sought advice from a financial advisor.
He just scraped together things from what he heard in doctors’ lounges. Although he provided an amazing upbringing for which I’m extremely grateful, he unfortunately didn’t plan well for his own retirement.
Fortunately though, he recently sold the home we grew up in, and it had long been paid off. The cash from that sale ended up being more than the amount he had in all his investment accounts combined.
Great Forced Savings Vehicle
All I remember thinking was thank God he had the mortgage. It actually forced him to save. Mortgages are often thought of as terrible things – after all, no one likes making monthly payments on anything.
But there are quite a few reasons why having a mortgage is very beneficial from a savings standpoint. For example:
Most experts suggest at least a 10% savings rate, with some, like the White Coat Investor, even recommending 20%. The truth is, thanks to life’s little expenses, many of us fail to come close to those percentages. But how many people forget to pay the mortgage every month? When the alternative is homelessness, most of us make it an easy priority.
Creates Long-Term Wealth
Statistics show that the average homeowner has a higher net worth than a renter. The US Census Bureau puts out statistics and the last time they did in 2013, they stated that homeowners have a median net worth of $199,557 vs. $2,208 for renters. That’s a 90x difference!
Why is this? This is a chicken or the egg situation – is it that homeownership leads to higher net worths or just that higher net worth people buy homes?
I think it’s a little of both. Homeowners are typically older making higher salaries than younger renters with lower salaries.
On the other side, over time, the homeowner’s property will appreciate 3-4% on average a year while they’re paying off the mortgage and gaining equity in the home. Most homeowners use leverage (put down 20%) to gain the benefits of the appreciation on the full value of the home, leading to an increased net worth over time.
A simple example of this: If a $500,000 home appreciates at 4% a year, then after one year, the home is now worth $520,000, a gain of $20,000. However, if you had only put down 20% ($100,000), your return on investment is 20% ($20,000 gain / $100,000 down payment). Over time, you can see how that multiplies your gains. (Admittedly this is a very simplified illustration without accounting for taxes & fees.)
Interest on your mortgage can be deducted at tax time, which means more money in your pocket. Although with the new tax care plan, this benefit has been reduced for some people, particularly in high cost of living areas. Mortgage interest can now only be deducted up to a $750,000 loan (for new loans) instead of up to $1 million as before.
Not Pay Capital Gains Taxes
Yes, it’s possible that you could pay nothing in taxes on the sale of your home even if you realize a nice gain. You also don't have to wait until you're 60 years old to realize this tax benefit. How many other investment vehicles can you say that for?
This is a tremendous benefit, particularly for those in higher tax brackets. If you’re single and have lived in your home for at least 2 of the last 5 years, up to $250,000 in gains is tax-free ($500,000 if you’re married).
Not Great as a Savings Vehicle?
Since nothing is perfect, there are some cons to thinking of a mortgage as a savings vehicle. For example:
Better Places to Save and Invest
This can absolutely be true. If you’re disciplined and save well, you can definitely make better returns on your investment than using your own primary residence. Unfortunately, with the nation’s abysmal savings rate and high credit card debt, discipline just doesn’t seem to be our forte.
True savings, some say, should be liquid – something we can tap quickly if needed. A mortgage, therefore, shouldn’t be used as an emergency fund. So lack of liquidity is a valid issue.
However, one way to remedy this is by having a home equity line of credit (HELOC) open and available to tap in the case of an emergency.
Honestly, that’s what I do. I don’t like to keep a lot of cash sitting in savings. I like my money to work. So I have a HELOC in place just in case of an emergency. I just have to be disciplined not to use it as a credit card for home renovations or to buy a Tesla.
Utilizing a mortgage to help you save may not be ideal for everyone, but I know for a good number of people, a mortgage is a great forced savings vehicle. It was for my dad, and I’m grateful. Now we just have to be smart and figure out what to do with this savings and his other investments for the rest of his retirement. But that’s a story for another post.
How do you feel about a mortgage? Do you feel like it’s a great way to force savings?