Saturday, July 21, 2012

Should You Get a 1% Mortgage? Probably Not.

If you get an Adjustable Rate Mortgage today, you can pretty much assume the interest rate will go up, over time.  Because rates can't really fall much further...

MSNBC recently was hyping adjustable-rate mortgages after that Zuckerstein kid got a 1% mortgage on his new mansion.

They breathlessly reported how great these mortgages were, and how people were using them to leverage themselves to invest in Real Estate.

Their argument was that a 1% mortgage would "improve you net worth" - which is specious.

The problem is, with ARMs, is that they can go up - and will, over time (they can't go much further down these days!).

Are these new super-low ARMs a good deal?  Usually not, and usually they are not a realistic option.

To get one, you have to have a lot of money in the bank.  You have to be solvent and have a lot of investments.   So, young dot-com Billionaires can get them, but Mr. & Mrs. Paycheck-to-Paycheck cannot.  So, likely, the point is moot for people like you and me.

But why would dot-com Billionaires want to get one?    Well, probably because they are getting the same bad advice we get from accountants, and also because they are not as rich as you might think.

Accountants tell you that you should get a big honkin' mortgage as it is a great tax deduction.   It also is a lead weight tied around your neck.   But since the Accountant doesn't have to struggle to make the monthly payments he can make such recommendations.

You cannot deduct your way to wealth, and while you should take deductions you are entitled to, seeking out ways to spend money to get a tax deduction makes no sense at all.   If you spend $1000 a month on mortgage interest, chances are, all it means is getting 25-30% back on your taxes.   You are not making money by taking a tax deduction.  Not paying interest at all is an even better deal.

But the people getting these mortgages, even though they are "rich" are often cash-poor.   If you are a dot-com Billionaire, you are a Billionaire only on paper.   Unless you can sell your stocks, you don't have the cash to spend on a house.

And you might think that, at a 1% interest rate, you could do better by investing that money in the stock market.

But for lesser people, such mortgages could be a trap.   The article mentions a "wealthy" young woman who bought investment properties using a 1.7% ARM note.   She did not want to cash in her investments to buy these properties, but instead preferred to borrow.

The only downside to this is, at 1.7% maybe the property is profitable.   But at 2.7% maybe it is break-even.   And maybe at 3.7%, maybe it is losing money.  And as the economy improves and inflation takes off, you can bet that in 3-5 years, interest rates will go up.

And at that point, it is too late to refinance on a fixed-rate note, as those are going to be far higher than the 1.7% original note.

For Average Americans who plan on staying in their home for five years or more (hopefully more), a fixed-rate note, particularly today, is a heck of a bargain.  Rates for these notes are below 4%, and in five years or so, the people who took out such mortgages will be pretty glad they did, as their mortgage rate will likely be half that of prevailing rates.  And as housing prices recover, well, they could be sitting very pretty, thank you.

But the fellow who took out the ARM?   He's screwed, as his mortgage payment will go up as the economy improves, and the only thing he can do is hope to sell his house in an improving market.

ARMs are tricky loans and can wipe out average consumers, if they are not careful.  With rates as low as they are, I am not sure why anyone would want to take out a variable-rate mortgage at this stage.  The rate can only go in one direction - up.