Sunday, November 21, 2010

Secrets Your Mortgage Broker Doesn't Want You to Know - Interest Only Loans

This is Bill Rayman of Mortgage Capital Partners. I am here to address a number of myths and misunderstandings about the mortgage business and in particular how it can affect you in refinancing and even whether or not you should consider refinancing.

Myth #3: It makes sense to pay off my Home Loan as Soon as Possible or Interest-Only Loans are Bad!

Myth number three is that it makes sense to pay off the home as quickly as possible. A corollary of that myth is that interest-only loans are bad. The fact is, it is not necessarily bad to pay off your home, and often it is simply not a good choice what so ever. There are several components to this answer.

The first is, not all debt is bad debt. Considering that you might be borrowing potentially hundreds of thousands of dollars for ten, twenty or thirty years, and you can lock that interest rate in today at under 5%. Plus, the interest on that money is very likely tax deductible, so if you're in a 25% tax bracket which is close to the national average, a 5% interest rate means your effectively borrowing 3.75%. Where else can you get debt like that, certainly not from your credit cards?

The second reason to consider not paying off your mortgage is this; think about the use of the funds. Paying down the principle, which is to say increasing your equity in the house, feels like a good thing and I respect that's a really good reason to do it if it feels good. From a strict financial point of view, your house is an asset and if you put money into any asset you want to see that the asset appreciates in value; that it grows. It sounds somewhat counter intuitive until you realize no matter how much you put in to your house in terms of the equity, whether you put down 100%, or you borrow 100%, the price of your home is established by the market. Therefore, paying money into your mortgage is technically a zero rate of return. With that in mind, the issue that comes up is if you didn't put it into your home, what else could you do with it? Right now, the investments in the market are very poor. CDs are paying on average 1.6% in the country, but that's today. Looking further down the road, we've been accustomed to five, six, seven, eight percent returns on investments. So if you can borrow from the bank at three, four, or five percent and put it in stocks or even just very secure treasury bonds; treasury bonds so much as there are secure bonds that you can probably be getting five, or six percent on, and ideally you probably will down the road. You are doing what a bank does, you're borrowing low, and you're investing high at a secure rate.


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