Written by John Regan, former Director of Sales, for equity research
Question: There’s a lot going on in my life right now: I’m graduating this year, I have a job lined up in my hometown, and my girlfriend and I are very serious–in fact, we’re planning on getting engaged very soon. My parents, of course, have taken this hectic time as an opportunity to give me lots of advice. One big one that keeps coming up is that when I get married, I should buy a house to live in rather than rent. They say it’s better to pay a mortgage than rent. Honestly, I know less than nothing about real estate. Can the experts explain the logic to me?
Answer:
A mortgage is simply a special kind of collateralized loan–but that explanation only works if you understand what a collateralized loan is, so let’s start there. Loaning money is a risky business, because loaning institutions don’t know for sure that borrowers will pay them back. In fact, on a large scale, they can be sure that at least some won’t. So they charge interest on loans, with the idea that the extra money being paid will cover for the losses accrued by bad loans (and, of course, they want there to be a little extra left over as a profit). That means it makes sense to set interest rates based on risk. Riskier borrowers pay more, reliable ones pay less, and the interest can drop significantly if something is put up as collateral for the bank to collect if the borrower defaults. If you stop paying your car loan, the bank can repossess your car and sell it off to make up at least some of the difference. A mortgage works the same way except, of course, that the collateral is the property the mortgage is on.
One of the tricky things about a mortgage is that the property can change value while you remain locked into the same mortgage. If you buy a house for a certain price and then it skyrockets, you’ll still be slowly paying off the original, cheaper price. The real estate market is healthy right now, realty gurus at SW Ohio Real Estate told us, so this is what many homeowners are enjoying right now. This is why the fact that Americans carry $14.6 billion in mortgage debt doesn’t freak a lot of people out.
The reverse is when the home plunges in value and the debtor ends up owing more than the value of the home. This is called an underwater mortgage, and it’s bad news. It happened a lot in 2008, when a less regulated mortgage market than we have today caused the economy to lose a lot of its value. Things haven’t been quite the same since 2008, and the American homeownership rate is now at the lowest point it’s been since 1965: 62.9%.
One other complicating factor with mortgages is that the government likes to get involved. Mortgages are made more attractive with tax breaks, and USDA home loans allow homeowners to get mortgages without putting down a big downpayment. Of course, there are also property taxes and other less beneficial government-related factors at play in homeownership.
Overall, though, the logic behind your parents’ plan is that you will be paying monthly for your living situation in the form of either rent or a mortgage–so why not make that money do some good by paying off a mortgage and working towards owning a valuable (and potentially growing) asset? In the end, your decision needs to take all factors into account, including property taxes, mortgage rates, and the real estate market in your hometown. Now that you understand the basics, you should be in a better position to make a good decision for you and your future family.
“The universe of mortgage lending has gotten to the point where there is a place in it for everybody.” — Joe Mays