Far be it for me to suggest that all real estate purchases should be made by cash. Realtytrac is one of the organizations that follows the use of cash in real estate transaction and over the last couple of years, 25 to 38% of sales have been all-cash. Right now, they’re at a 9 year low because as this post will discuss, interest rates are much lower than they ought to be relative to other strengths of the economy. Even buyers that can afford to use all-cash are often using a mortgage because relative to the rest of the economy, 2016 money is dirt-cheap.
In Colorado Springs the availability of veterans benefits due to the high active and retired military populations increases homeownership rates and also increases the use of mortgages as the instrument to secure financing used to purchase a house.
One of the unspoken dirty secrets of real estate is the Latin origin of the word mortgage. Those first three or four letters might be familiar to the more verbal or literate in the audience:
Yeah, they’re all related.
As the image above indicates (courtesy the great gods of Google) the original latin origin comes from the use of the word “dead”. As Latin evolved into more western European languages, it was paired by some banker or other usury-maker with the French “gage” to indicate a pledge, also known in more modern parlance as a vow or a promise. In the very literal origins, “mortgage” is a pledge to perform on a debt and put that debt to-death by a series of installment payments. This is achieved by a process knwon as amortization, and yes, there again is that root word “mort”. Amortization is not a love affair with debt (although it is often treated as one); instead, it is the agreed upon schedule of payments from the debtor to the lien-holder who holds the note and is due the return on their investment by a set schedule. In the meantime, that lien-holder will make the bulk of their money (their profit) in the first few years. Each successive year more and more of the monthly payment gets applied to the original sum of the debt (the principal) but in the first few years, regardless of the interest rate, the majority of the funds go to the lien-holder for interest.
Commonly known but rarely considered is that the lien-holder always wins in re-finance crazy America. I have personally re-fi’ed my house three times and the third time ended up owing more than I did on the original note in 2004. Yes, my income was more and it was used to pay for other investments, but what’s notable is that each time a consumer refinances their note, the whole 30-year (assuming it’s a 30-year note) schedule starts over.
This is the definition of death by a thousand little cuts, or more precisely, 359 little cuts. After one year and $13,750 in payments, the principal is only reduced by $4226. The bank would have received $9523 in interest in that time, and that’s with rates still near historic all-time lows. Think of it this way: for every $4 of principal a homeowner gains in the paying of their mortgage, a bank makes $9 in interest that first year. That’s at 4% interest rates.
Now look at the same scenario at 6% interest rates, a rate more normal in history and frankly, more in-line with where things ought to be based on the present late-Fall 2016 economy:
The monthly payment for the same amount borrowed is almost $300/month higher
In a perverse twist, despite the much larger monthly payment, fewer dollars per month are applied to the principal due to the way amortization schedules work. So even though this borrower at 6% makes $3500 more in payments over 12 months time, that borrower would have only gained $2950 in principal at 6%, Even more incredible, the bank would have been paid $14,320 in interest in 12 months time, or a full $4800 more in interest at 6% than at 4%. The 4% borrower gained $4 of principal for every $9 they gave the bank their first year; but the 6% borrower gained just over $2 in principal for every $0 they gave the bank in the same time. This is not death by a thousand little cuts. This is a straight-up financial clubbing. More importantly: this is normal and the way things probably ought to be (but aren’t!) in Fall 2016. A 6% rate is much closer to what interest rates ought to be with national unemployment less than 5%, with GDP growth over 2%, with real estate markets rising 5% nationally and with Wall Street in excess of 19,000 than But look where rates are today:
The average rate this year has been less than 3.7%, and even now, rates are on-par with where they have been the same time of year over the last four years.
So is it a good time to buy? As far as interest rates are concerned, it’s a staggeringly good time to buy.
This is not intended to discourage the use of a mortgage. Not in the slightest. But it is to encourage financial knowledge of why the vehicle of choice to acquire real property in the United States goes by such a morose (pun-intended) name. Participation in a real estate purchase is often a consumer’s biggest participation in the economy at large. A mortgage is a financial obligation to repay, and basic intelligence about how they can benefit or degrade your future is vital to a successful real estate investment.