Renting Vs. Owning: Benefits of 30yr Mortgage & Why HELOC is bad

Last few days the stock market is going down and my portfolio has gone down quite a bit. I have been checking out the real estate as an investment option that can help me with creating some cash-flow. I am window shopping on RoofStock for a while now. Roofstock is a portal where you can buy and sell rental properties. You should definitely check them out. You will get $500 credit, just for signing up with the link.

The other option where I have already invested money is Fundrise. I have invested mainly in debt instruments linked with real estate. Currently, I am awaiting the 3rd quarter dividend. You can get started with $500.

Now, being an IT consultant, I can’t stop moving around. I am moving back to Boston from central Jersey in 2 days. And that made me think, is renting worth it? IF you are from Boston or if you have lived in the suburbs, you know how expensive it is. Paying $2000 as rent just appears to be a waste of money. But, then the homes are so expensive that it is difficult to afford the down payment.

In this post, I would tell you what I found out about renting vs owning. I will share something information that will help you decide if you want to own or rent. And in case you are planning to own a home, I will help you decide what mortgage should you take and why you should avoid HELOC.

You know, I spend way too much time on the internet reading all about the money related topics and studies. And I am going to talk about real estates and Millennial financial habits. Both of those are amazing in their own respective ways and apparently also CNBC agrees with me because they featured this article on the very front page titling it apartment rental demand soars as more Millennials believe it’s cheaper than owning a home like come on.

Single-family property owners are realizing that renting out their single-family homes is becoming very profitable way, more than it would be if they just bought it to try to resell it. Because renting generates long term cashflow.

In fact, at some point developers are going to overbuild apartment buildings and the demand for them is going to drop simply because the inventory is so high and the people who want a single-family home or a smaller building will pay a premium for that because it’s different.

So at the end of the day, it’s Millennials are not buying properties. This is really good for the landlord because that means they’re renting. So in every single direction for the way, I see it as a Buy and Hold real estate investor who rents out properties all of this is just a win-win.

Anyway, that’s my thoughts about what’s been going on with the trend away from buying and it’s a shame that more Millennials cannot afford to buy real estate. Because it is so expensive in the areas where the higher-paying jobs are. One can argue that due to low-interest-rate policy adopted by fed, the asset prices are really out of control.

Buying a real estate is like making long term commitment. And when a higher paying or better job opportunity shows up, the homeowner cannot really move. This is another reason why homeownership is not really attractive for many.

The other reasons are, of course, now we are moving towards an asset-light economic model. Uber does not own cars, Air BNB does not own hotels. Own stuff takes too much effort. The maintenance, calling the plumber, maintain the yard – just too much work. You can rent and let the owner all this for you.

And finally, think about the down payment and selecting what mortgage to get. It is just not the interest you would pay, how long do you want to carry debt? Or what will be the opportunity cost? Let me give you my perspective on the mortgage.

Why getting a 30-year Mortgage is better than the 15-year mortgage?

  • So here I am explaining how you can actually be better off getting a 30 year mortgage, even though it appears that you can be paying a lot more money over the term of the loan than if you just got the 15 year mortgage, but see it’s not until you really understand the Dynamics of having a 30-year mortgage.
  • Go visit the web site of your bank, check their Mortgage section and you’ll see that the 30-year mortgage rate (probably) is sitting at 5% But the 15-year mortgage rate is only a 4.75%. This basically just means you’re going to be paying a lot less interest over the lifetime of the loan.
  • Now the next advantage on the surface of the 15-year loan is pretty self-explanatory. And that is you pay off the property and 15 years versus 30 years. I know people who made this first priority to pay off their mortgage in 15 years, so they can own their home afterward.
  • And finally, the last Advantage here is that you end up building up a lot more Equity with the 15-year loan much faster than with the 30-year loan. And this helps, you will have a lot more equity on your side in case you need to use it.
  • But however, there is a dark side when it comes to the 15-year loan and that is, in order to pay off the home in 15 years your payments will be significantly higher.  A lender is going to qualify you to buy less real estate that if you did a 30-year loan because they have to take into account higher mortgage payments to pay off the home in 15 years.

What about the advantages and disadvantages with a 30-year loan

  • Now with a 30-year mortgage, you have a lower monthly payment. And now have an additional 15 years to pay off the property. This means you’re gonna have more money left over in your pocket every single month for possibly higher-yielding Investments than what you’re paying for a mortgage.
  • When it comes to investing in real estate because you have a lower payment you’re going to be able to qualify to buy more real estate and chances are this means you will just end up making more money. Even if you do not put that additional money into more real estate, just put it is stocks or low-cost index fund.
  • There are a few downsides with the 30-year mortgage. Number one is that your interest rate is going to be slightly higher like our last example. On a 15 year loan, you are paying for point three seven five percent interest over 15 years on the 30 years that’s going to cost you five percent.
  • That also means you’re going to be building up Equity a lot slower when you go for the 30-year mortgage versus the 15-year mortgage and because of that it’s going to take you a lot longer to pay off the property in full.

Why a 30-year mortgage is actually the better Superior option over the 15 years?

Let’s take a real-world example of a $500,000 loan. Your down payment is $200,000. Let’s first start with the example of a 15-year mortgage option at or 4.75% interest for three hundred thousand dollars every single month. That means your payment is going to be $2372.00 per month.

This amount includes interest and the principal. Because you end up aggressively paying down the loan balance ( well over 15 years) you end up paying less interest over time and because of that, you end up paying off your home much faster in the 15 years. And, you build up home equity much faster than you would have with a 30-year mortgage.

This means that over the lifetime of the loan. You’re going to be paying a $127,000 in interest over 15 years. This is way less than you would have paid with a 30-year mortgage.

Now, let’s take that same loan example and just assume you got a 30-year mortgage. Now with this, your monthly payments are going to be $1610 every single month. So every month you save $762 on a mortgage payment. But with a 30-year mortgage, you pay away less principal payment for the first 20 years.

That means, you build up equity really slowly for the first 20 years, and then cover a lot of ground in the last 10 years. And the second this is you’re going to be paying $279,000 in interest when you go and take out a $300,000 mortgage for 30 years.

So far you would be thinking a 30-year mortgage is really bad. Allow me a few more moments to enlighten you.

Inflation is the benefit you get with a 30-year mortgage. An average inflation rate of about 2% Annually. Our money in the future is going to be worth a lot less than the money we have right now today. Considering your income keep up with inflation, your earning will go up in the future.

This means the total interest for a 30-year mortgage that you see at the very end is not adjusted for inflation, meaning the total amount of interest you pay is considerably less in today’s dollar, thanks to inflation. You would pay considerably less part of your paycheck as a mortgage at the end.

The same thing happens with rental properties. With time you will increase rent just to keep up with inflation. But your monthly mortgage payment will remain the same for 30-years. As you continue increasing the rent, you will generate more free cash flow, although that will have less purchasing power because of inflation.

Second benefit is the amount you save for monthly payment, by converting to a 30-year mortgage. You need to put that money that will beat inflation and generate a ton of return in the future. Like an IRA, ROTH or traditional 401K. Or you can buy an index fund as Warren Buffet suggests. If you let it compound for 30 years and if you generate 7%, the initial 100 dollars will be worth $400.

You can save up the capital and buy another rental property that would generate free cash flow for you. What I am trying to say, the money you save on payment can be seed capital for your next cash-generating asset.

And then always you can pay down your mortgage, with your tax refund or bonus. Nothing will stop you from paying down your 30-year mortgage early. You can pay it off at any time you wish to. A 30-year loan ends up giving you is just flexibility. It gives you the option to pay it off over 30 years or if you want to pay it off sooner, you can go ahead and pay it off sooner.

With a 15-year mortgage you will build up home equity faster, it isn’t really going to be making you money. Now. This might be a very unpopular opinion but having money tied up in a property that’s not easily accessible for other higher return investments just means you’re going to be ending up making less money in order to actually get that Equity that you have in the property by making higher payments.

You will either need to sell your property or do a Cash-out refinance which then just starts the whole mortgage process over again and then defeats the purpose of the 15-year loan, to begin with. With a 30-year loan, you have access to your money when you need it because you’re making lower monthly payments and tying up less money in real estate allowing you more flexibility to invest or do whatever you want to do with your money.

Here is one word of caution,if you decide to buy iPhone and other depreciating junks with the money you save with a 30-year mortgage, then please go for a 15-year mortgage. That way you put your money to build equity. Otherwise taking a 30-year mortgage will not make any sense. So, the first thing you need to do is to ask yourself, what are you going to do with the cash you save on monthly mortgage payment?

Now let us see how you can pay down your mortgage sooner. yes, even if you take out a 30-year mortgage you can pay down your mortgage in 15 years.

Should you be paying down your mortgage early with a HELOC?

Let us explore the concept of paying down your mortgage early with a HELOC. But once I started digging deeper, I realized that this method is frequently published in emphasized by people who don’t understand math as well as Banks. Banks have a financial interest in you spending more money with them.

So they make HELOC sound way better than it actually is. How you can pay down your mortgage early with this and why you should also never do this and then I will tell you how you can actually pay down your mortgage early.

Once you have build up a substantial amount of home equity you can use a home equity line of credit. Like if you ever need cash for an investment, but you don’t want to refinance your entire mortgage a home equity line of credit is actually really really useful and many people also use a home equity line of credit to fund of business or pay for a home remodel but using it to pay down the mortgage, on the other hand, can get a little strange.

So the concept of paying down your mortgage with a HELOC goes a little something like this where I have a $500,000 home but I have a $200,000 mortgage. This leaves me with $300,000 worth of home equity line. Now I can open up a HELOC and I can borrow $100,000 from that credit line, then after that, I can down the mortgage with the money I borrowed from HELOC.

There is still on the $500,000 home. But now I will have a hundred thousand dollar mortgage instead of two hundred thousand dollars. And then I will have $100,000 HELOC which I will need to pay off.

So basically the HELOC just becomes like a low-interest credit card for you to draw from while you’re paying it down at the same time. Then once it’s paid down voila, you’ve saved money on your mortgage interest because you made a sudden lump payment and paid it down much faster. Now, the question is did you save money with paying off the mortgage early?

  • First of all a HELOC is not a good option because you’ll pay with the traditional mortgage that costs you 4% interest by borrowing more money through a HELOC at 5%. Like even if you pay off that four percent loan faster, you’ll still owe the exact same amount of money and now you’re paying 5% interest on that. Which means you’re now losing money.
  • Secondly, HELOC generally comes with what’s called a variable interest rate loan, which means that the interest rate you pay will fluctuate over time meaning this could actually be higher in the future. Even if you’re borrowing money right now at 4% interest rate two years from now, it could very well be possible this could jump to like 7%.
  • To lure you in lenders will offer you very attractive promotional rates. So, you open up a HELOC. Usually, that includes a low-interest rate for the first 12 to 24 months that might be on par with your mortgage and then after that, it’s going to jump to like five to seven percent if you don’t pay it off in full before the promotional period ends.
  •  You also have to pay transactional costs before you get a HELOC, including appraisal fees, transaction fees, processing fees, Title costs, and the list goes on. These all need to be factored into the overall cost of applying for this line of credit.
  • The interests you pay on a home equity line of credit is often not a tax-deductable, if you use that to pay off any existing debt on the other hand, your mortgage interest is a full tax deduction on the first seven hundred and fifty thousand dollars you borrow. So with a HELOC you end up automatically losing that deduction.

How to Pay off the mortgage sooner and save money?

If you actually want to pay down your mortgage faster and save money here are the real ways to do it.

  • The first is what’s called a refinance. This is where you go to a bank and they will give you a brand new loan the replaces your previous loan. Now this works when interest rates go down, you can get a lower interest rate if you just get a brand new loan. Your monthly mortgage payment will go down, provided you do not change the length of the mortgage.
  •  The second method to pay down the mortgage early is to make what’s called bi-weekly payments. Now the way your mortgage is calculated is by your total outstanding loan balance. So instead of making one payment per month, you can make half of that payments every other week.

There are 52 weeks in a year. So you’ll be able to make 26 bi-weekly mortgage payments every other week. And then if we just math a little bit more we all know that 26 half payments equal 13 full payments per year instead of doing 12 per year.If you just make bi-weekly payments instead of making one payment per month you pay off your mortgage for years earlier and you would save about thirty-three thousand dollars in interest.

That’s all for just making half of your payments every other week instead of just doing one payment monthly. So if your goal is to get rid of your mortgage as soon as possible and you don’t want to spend any extra money doing so then absolutely go this route. a two-week difference is nothing just to pay down your mortgage faster, especially when you spread that out over an entire year.

  • So the third way to pay down the mortgage early is making extra payments towards your loan. So consider that with a mortgage payment, you’re making 12 payments throughout the entire year every single month. But if you ever get an end-of-the-year bonus or any lump sum check or any sort of tax return and you throw it all into the mortgage that could cut down your mortgage by a lot.

Just making two extra mortgage payments per year can cut down your mortgage Time by seven years. So if your goal is just to pay off your mortgage early than just consider doing this any time you get an unexpected windfall of cash like a tax refund or a bonus at work or any sudden commotion or whatever.

  • The fourth method is simple. you just got to pay it off using your own money by just paying it down sooner with your own money. If your mortgage payment is $1400 per month for 30 years and you decide to pay $2,000 per month instead. You’ll pay off your mortgage 10 years sooner up that to 2200 dollars per month and you’ll pay it off almost 13 years sooner and you’ll save about a hundred thousand dollars in interest over 30 years and that’s pretty much it.
  • The fifth option is something that banks will never tell you to do is just to shop your loan around. What you’ll do is you go to One bank and get a rate quote. Then you take that to the second bank and ask them to beat it. Trust me. They almost always will then you take that new quotes and take it to a third bank and ask them to be that one and they will then you continue doing that shopping.