It’s Your Money Column – Ric Edelman: Mortgages

Issues about the economy, the stock market and job loss are keeping people on edge. We don’t know what will happen to our retirement funds or even our jobs.

The financial press is full of suggestions about what to do with savings and investments. In his new book, "Financial Security in Troubled Times," Ric Edelman suggests that one way to prepare for unknown financial times is to take the longest mortgage possible, even refinancing if your mortgage is low.

This is Ric’s example. Two people each earn $50,000 a year. Each has $20,000 in savings and each buys a $120,000 house. Pat uses his $20,000 as a down payment and opts for a 15-year loan at 7.5 percent. He wants to pay off his debt as soon as he can, so he sends an extra $100 a month to pay down the principal.

Ed takes a 30-year mortgage at 8 percent. He puts down 5 percent ($6,000 of his $20,000 savings). His monthly payment is smaller than Pat’s because his loan is twice the number of years. Ed gets a bigger tax write-off for interest deductions in the early years of his loan – 90 percent of his payment is interest compared to 67 percent of Pat’s payment.

The crucial idea in Ric’s example is that Ed will be better off in the future if he saves the difference between what he would pay with a 15-year loan and a 30-year loan. He would have $14,000 left from his original savings plus a $156 payment each month that he could sock away for future needs.

If both Pat and Ed end up without a job for a period of time, Ed will have savings to cover his mortgage payments and other expenses. All of Pat’s money will be tied up in his mortgage. If he doesn’t have a job, Pat could have trouble refinancing or getting a home equity loan to tide him through a time without income.

This strategy, of course, does not work if Ed gets the longer loan and spends the difference.

The only action that leads to total control in paving the way to financial security is to reduce our daily spending and save more. Trying to grab the hottest investment often backfires and results in buying high and selling low, paying huge fees and commissions and paying more in taxes.