Got Cash? Forget About Mortgage
Question: Is it a bad idea to pay cash for a house? I live in an area where housing is pretty cheap, and I’m interested in purchasing the house I’m now renting for $400 a month. I think I can buy it for about $30,000.
I am 48, make $45,000 a year and have a 401(k) at work. My current savings outside my retirement fund are minimal as I’ve been paying off credit cards. But my mother recently passed away and I’m expecting a $70,000 inheritance. I’d like to use this money to pay off an $8,000 car loan and buy the house, using the rest to invest. I also would use the money I’ve been paying for rent and the car to increase my savings.
But my sister says I should get a mortgage instead of paying cash, because of the tax deduction. Is that true?
Answer: Would you pay somebody a dollar to get back 27 cents? That’s essentially what you’re doing when you get a mortgage if you don’t need to.
Every dollar you pay in mortgage interest gives you a tax break of just 27 cents, assuming you’re in the 27% federal tax bracket.
That example also assumes you’re able to itemize your taxes -- and most Americans can’t. They take the standard deduction because their deductible expenses, including mortgage interest, are too low to justify itemizing. The payments on any mortgage you get would be pretty small -- as in less than $200 a month -- so you probably wouldn’t get much if any tax benefit from a mortgage unless you’re already itemizing.
It might make sense to get a mortgage if you’re pretty sure you can get a better return on your money elsewhere. Given the small amounts involved and that you’ll have money to invest even after you buy this house, you probably don’t need to be too concerned about this issue.
One small piece of advice: Consider reversing your plans for the excess inheritance and money freed when you pay off debt. Establish a six-month reserve with the inheritance, and use the extra income to add to your investments. That will allow you to pay cash for the inevitable maintenance and repairs a house needs so you don’t wind up back in debt. Monthly investing will help smooth out market ups and downs through dollar-cost averaging.
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Student Loans Are Like Other Debts
Q: Your advice to limit student loan borrowing is totally unrealistic!
You said people shouldn’t be devoting more than 10% of their monthly gross income to student loan payments in their first year out of school, but there’s no way I could have gotten the education I did if I had limited my borrowing to that amount.
Now I’m working in my field, but the payments are nearly killing me. There should be some government program with loan forgiveness to help those of us who had to borrow more.
A: It’s not unrealistic to expect people to be able to afford the things they buy, whether it’s a television, a home or an education.
When people refuse to consider the consequences of their borrowing, they wind up as you have: overwhelmed with debt and unable to save for any of the other important goals of life, such as a home down payment, retirement or your own kids’ education.
The federal student loan program caps the amount most undergraduates can borrow at $23,000. That amount of debt is a little bit high for most liberal arts majors who graduate, but more than manageable for most business majors (who tend to get paid more).
The problem is that there are plenty of private lenders out there more than willing to lend you just about any amount you request for an education. They know you’re pretty much required to repay, because you usually can’t get rid of these loans in Bankruptcy Court.
So you need to be the one to put a limit on your borrowing. If you can’t afford the education you want, you need to find an education that you can afford.
(If you missed the formula for affordable student loan debt, here it is again. First, figure that your payment on each $1,000 in student loans will be about $12 a month -- a conservative estimate. Then find out how much monthly income you can expect after graduation. Divide that income by 10, and that will help you determine your maximum monthly payment and thus the maximum you should borrow for your education.)
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Liz Pulliam Weston is a contributor to The Times and a columnist for MSN.com. Questions can be sent to her at asklizweston@hotmail.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk columns, visit The Times’ Web site at www.latimes.com/moneytalk.
