Free and clear
At a time when some people in the Southland are struggling just to pay their mortgages, the idea of actually paying one off might sound like a pipe dream.
It doesn’t have to be, said Allen Fishbein, director of housing and credit policy at the Washington, D.C.-based advocacy group Consumer Federation of America, who believes the best way to build home equity and wealth is paying down -- and eventually paying off -- the mortgage.
Recently the focus had shifted to building wealth through appreciation, Fishbein said, “but values go up and down, making this a less reliable method than paying down debt.”
This can be achieved in several ways, including making one extra mortgage payment each year, putting spare amounts of cash toward the principal or using a sudden windfall, such as a tax refund, to pay off a chunk of the debt.
According to 2006 U.S. Census Bureau figures, the most recent data available, a little fewer than one-third of homeowners has no mortgage.
But is that a wise position to be in? The answer may depend on how you crunch the numbers as well as on generational and cultural differences.
Although some homeowners aim to be mortgage-free by the time they hit retirement, others question that strategy. Why bother paying off a mortgage, they ask, when that money can be invested more profitably elsewhere -- or spent?
They see little downside to carrying a mortgage and tout the benefit of a hefty tax write-off for the interest paid on home loans. They also have no qualms about tapping home equity -- not necessarily to buy BMWs or for trips to Europe but perhaps to pay college fees or fund improvements that will add value to the home.
Tom Davidoff, an assistant professor in the Haas School of Business at UC Berkeley, sees a generational divide in these positions, contrasting those for whom the recent years of affluence are all they’ve known with the experience of those who themselves, or whose parents, lived through some major economic hardships.
“This generation hasn’t seen the economy really stink,” he said. “The fear of debt isn’t there.”
People who are mortgage-free are “very concentrated among the elderly,” Davidoff said, citing the latest University of Michigan health and retirement study showing the level of mortgage debt among retirees is, on average, only about 11% of their home values.
That’s something he doubts will be repeated by many of today’s younger homeowners to whom “it seems crazy to die with $800,000 untapped.”
Just last week, the Federal Reserve reported that for the first time since 1945 the total amount of equity Americans had in their homes fell below the total amount they owed on those homes.
Connecticut College psychology professor Stuart Vyse, who has researched behaviors associated with debt, said that as more Americans have come to rely on credit, many today have no experience in saving. “They don’t have that positive feeling of putting money away and being ahead of the game.”
Vyse, whose book “Going Broke: Why Americans Can’t Hold On to Their Money” was published last month, said attitudes toward mortgages are colored by our increasingly fast-paced culture.
“People tend to be nearsighted,” Vyse said. “Lots of decisions are based on instant gratification rather than long-term responsibility.”
The author said that’s why buying homes with no money down became popular. “It’s putting off the pain.”
Having bought property in Santa Barbara, Palm Springs and Antibes, in the south of France, Mike Stoltz also has witnessed cultural differences in how people in the United States and Europe regard mortgages.
Stoltz, 49, who retired four years ago but still works for a few clients at his Santa Barbara-based Earth Investment & Mortgage Co., spends several months a year in France.
When negotiating a mortgage to buy the French property nine years ago, the first question he was asked was his age: “It’s just assumed you’ll be paying everything off by the time you retire.”
However, in the U.S., he said, people are encouraged to maintain mortgages, partly because of the tax benefit on the interest. Since 1987, mortgage interest has been deductible on loans of up to $1 million to buy a home and up to an additional $100,000 borrowed against the equity. This applies to the main home and any second home, even if it is rented out for part of the year.
However, since the interest component in each monthly mortgage payment slowly diminishes over time -- and the standard tax deduction slowly increases over time -- there comes a point at which the tax advantage disappears.
Still, Stoltz reckons this tax-benefit system creates a mindset that leads people to borrow for things they could not otherwise afford, adding to an ongoing debt burden.
That’s a trap that Stoltz and his life and business partner Arnie Kassoy, a lawyer in Beverly Hills and Santa Barbara, have made sure to avoid. Last year they paid off homes in Palm Springs and France that cost a total of about $1.3 million to buy and improve; this year Stoltz plans to sell his Santa Barbara home, eliminating that mortgage as well.
The choice between paying down a mortgage or making other investments largely depends on individual circumstances, said George Hanzimanolis, president of the National Assn. of Mortgage Brokers.
The feeling of comfort and security from being mortgage-free “should never be discounted,” he said. However, current low interest rates, combined with the tax breaks, can mean an effective mortgage rate of about 4%, so secure investments, such as CDs or savings bonds, might provide a better return and at least merit a “side-by-side comparison.”
Phillip Cook, a certified financial planner and president of Mogul Wealth Management Inc., based in Torrance, takes the hard-numbers approach. Those prepared to accept an element of risk can certainly find better-paying options, he said, through such reasonably secure investments as corporate bonds or preferred stock.
Cook also sees an additional potential disadvantage in putting all the eggs into real estate equity -- a lack of liquidity. Money invested elsewhere may be easier to access, especially at tight lending times like these, in case of unexpected events such as a serious illness or a job loss, he added.
Colleen Hernandez, president of the Homeownership Preservation Foundation, a Minneapolis-based national nonprofit that helps troubled homeowners, is aware of the shifting perspective on mortgages from both a professional and personal standpoint.
“Today homeownership has moved from a housing situation to an investment situation,” she said. “Some people use their homes as an ATM. They don’t want to leave the equity in the home.”
The idea of repeatedly refinancing and extending the time span of the mortgage does not sit comfortably with Hernandez, who shares the mortgage-free goal of her parents -- a concept rooted in the generation that lived through the Depression era of the 1930s and on into World War II.
Finally getting the mortgage monkey off one’s back was such a big deal for many people that they would celebrate by holding mortgage-burning parties, sending the defunct document up in smoke to signal they -- not the bank -- now owned the property. Today people can go ahead and celebrate but are advised not to burn any documents.
“I like the old days,” Hernandez said. “Now many homeowners are just renters with their name on the title.”
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(BEGIN TEXT OF INFOBOX)
Figuring out the smartest strategy
Homeowners pondering their best move might benefit from the number-crunching found in the March edition of Consumer Reports magazine.
While taking into account a wide range of variables across different time spans, magazine researchers examined the case for paying down the mortgage by an extra $100 monthly or investing that money each month in a broad-based mutual fund.
They found that home values averaged annual increases of about 6.5% compared to gains of about 10% for an index-linked mutual fund. The longer the period of home ownership, the wider the gap.
However, the report also acknowledged that less tangible factors come into consideration in the decisions homeowners make about their mortgages.
-- Frank Nelson
