An excellent discussion emerged from my post about whether or not debt should be part of your budget, and that is:
Is your mortgage a form of savings?
I am firmly, strongly in the camp of: NO it is not. It is a debt.
Let me explain why.
1. YOU DON’T OWN THE HOUSE YET, THE BANK DOES
Some argue that paying into a mortgage, is forcing you to save your money because it goes to interest but it also goes to the principal of the home, which will (hopefully) increase in value in the future and be a fixed asset in your portfolio.
I can see the logic of this being true, as you are paying into the principal and you will own the house in 25 years (or eventually), and it is an investment you can then re-sell to release the locked value.
It all sounds great but…. you don’t own the house yet.
The bank does.
To put it simply, if you were to miss a mortgage payment, the bank wouldn’t say:
Oh Jane, you’ve been such a great saver, paying off this mortgage and debt that you incurred that we are going to give you ALL the money you paid towards the principal back in cash, and take the house in exchange.
No no no..!
The bank just takes your house because you defaulted on the payments to re-sell and get the rest of their pound of flesh back, and that’s the end of that.
If the bank wanted to get their money back today, where would you get the cash to pay them back?
It’s locked in your house, right? And you can’t sell half a house.
You have zero actual savings until your mortgage is gone.
2. A MORTGAGE IS A DEBT, AND A DEBT IS A FORM OF DELAYED SPENDING
Don’t have the cash now? What do you do? Put it on a credit card, line of credit, or mortgage?
Well, you spent the money then, didn’t you?
A house is slightly trickier because it is an investment in the future after you’ve paid off the house completely and it becomes a fixed asset in your portfolio to hopefully appreciate in value, but you could say the same thing about any other consumable.
Why not invest your money in buying antiques by taking out a line of credit?
Fine art?
Designer clothes from a defunct designer’s line, all in the hopes of it being worth more than what you paid for it today?
It’s the same thing.
Paying money into a mortgage (debt) is a form of delayed spending because you didn’t have the cash on hand to pay for it 100%.
You borrowed from the bank to spend it on buying a house to live in. Yes, it is practical because you have a roof over your head, you can presumably resell it in the future to clear the mortgage and fees, and perhaps pocket a little profit from doing so, but at the end of the day, you spent money you didn’t have.
3. SAVING MONEY DOESN’T HAVE TO COME IN THE FORM OF DEBT
You could simply just save money and not get a mortgage (a debt) to do so. Why not just put the money into your bank account and invest it?
You don’t need to incur any kind of debt to save money.
I do agree that unless it becomes a bill some people can’t fathom saving money without spending it on something, which is why a mortgage COULD be seen as a form of forced savings, but … that just makes no sense whatsoever.
Get a mortgage, buy a house, but don’t be fooled into thinking you own anything or have any savings until that debt is gone.
You’re just paying the bank for the privilege of living in their asset.
Sasha Perdue
Here’s my problem with this. For most people, unless you live with your parents or bum on a friend’s couch, you’re gonna need a place to live. And you essentially have just 2 options: Rent a place or buy one. To me, this argument should be couched in terms similar to those comparing leasing a car vs buying a car via loan. And just like it’s almost always better to buy the car, it’s almost always better to buy the house, because after the lease ends you’re left with nothing, whereas when you buy on loan, when the loan is paid off, you own it in full. It doesn’t matter if the house loses value over that time, you still have something that can be sold for some amount.
Let’s say, for example, you buy a $200,000 house with $10,000 down at 4% for 30 years. Your monthly payments would be $907 per month. At the end of 30 years you will have paid $326,552 on the mortgage. Total house price after 30 years: $336,552. Now lets see your house loses half it’s value. If you sell your house now, you’d essentially have lost $236,552 (plus closing costs and house maintenance and such) if you look at it as an investment. However, if you compare it with the cost of renting the same house, even if you found rent for as low as the mortgage (and usually rent is more than the mortgage. For example in my area, a 3 bed apartment runs between 1000-1500/month whereas a similar house or condo mortgage would only be 400-800/month), you would’ve spent $326,552 on rent, but you wouldn’t be able to sell your house at the end to recoup any of that. So unless your house drops down to being absolutely worthless, it’s still going to be better than renting.
Potato
@Sasha Perdue: You’re missing almost all of the analysis, Sasha. Check out a rent-vs-buy calculator, for example.
But just as a thought experiment, imagine you can rent a $1,000,000 condo for the scandalously low rent of $1000/mo. At that price:rent you’re obviously better off renting — the rent could be covered just by putting the $1M in a GIC, and if you needed a mortgage forget it, the rent is less than the interest part alone. And of course, that contains the key part of the answer: you’re not left with nothing by renting, you’re left with a big pile of investments that generate income to help pay the rent.
So there will be some price:rent where renting is better. Then it’s just down to the math as to where that point is. If you can buy a place that costs $1250 to rent for only $200k, you’re likely going to be better buying (price:rent of just 160x), but that’s not the case in many of Canada’s large cities (near me in Toronto, price to rent is double that).
save. spend. splurge.
The calculation I like to use is Monthly Rent x 100 = true, good deal value of the home
I rent my place for $2100 a month x 100 = $210,000 .. the owner paid at least $500,000. Not a good deal for her after all.
save. spend. splurge.
Good point but you’re forgetting all the added, hidden costs that come with buying and selling a home (Realtor fees, taxes, new home buyer’s tax), not to mention the maintenance you will have to pay that is already included in your rent to begin with.
My dryer broke the other day. I’d be out $200 for a service call but I called my landlord, she came, fixed it, and paid for the $200 serviceman fee.
If she had to replace it completely, it’s another couple of grand (it’s a high end dryer). I am out $0 from that problem because I am already paying for it in my rent, not to mention the condo fees, the interest fees on the mortgage that don’t go 100% to the principal….
Hemgi
Interesting.
Same logic apply to stock market. If you buying as an example, Bombardier BBD.B, what are you buying? Shares of the company? Shares of the building? Shares of the patents? Yes, and you can claim that you own it… but is not true. The bank is the owner. Most of the company have debt (BBD is one of the worst, debts being 7B and market Cap is 6B, so when you buying company stocks, you buying part of their debt and honestly, I much more prefer managing myself my debt on my mortgage than letting other people managing my debt obtained through stock purchase because if I need to cut my vacation to pay my mortgage, I know I can do it.
save. spend. splurge.
You make a good point. I suppose for me it is a lot more concrete with a house than it is with stock.
SarahN
I can see where you come from on this.
I don’t think most people, myself included, can save and buy a property outright. You can and will, and my grandfather did. That being said, mortgages offer an opportunity, at the cost of interest. IN the meantime, however, I am paying for somewhere to live (though now I’m a landlord, someone else is paying me etc etc). I do pour money into the offset to offset the mortgage, and you’re right, the bank could take my house if I missed a payment. Which would be in about two years time, as there’s enough in the offset to cover a year or two of monthly payments, which are automated. My thoughts are that if I lost my job, and couldn’t pay the mortgage, I would sell in those two years. Perhaps at a loss, sure, but given in Australia, it’s common to buy with 20% down, one makes the (perhaps false assumption) that you could sell for 80% of the original sale price, to satisfy the mortgage owing on the bank, and be back to square zero. All based on assumptions, agreed.
I don’t invest more than about $10k. Why? Cause I don’t understand it enough – and whilst you helpfully write posts, they are Canadian or the US focused, and the options/brands etc, are known and therefore I don’t immediately understand. It’s a cop out, I could read more and know more.
save. spend. splurge.
LOL!! Challenge accepted. I am going to research ETFs for Australia now 🙂
SarahN
@save. spend. splurge.: THANK YOU! I will read what you write :p
save. spend. splurge.
You had better!
NZ Muse
@save. spend. splurge.: Hey, may as well do NZ while you’re at it! I understand we only have a couple of options anyway.
save. spend. splurge.
I’ll group you two together 🙂 Have to find time this week to do some research.
ArianaAuburn
Another thing to consider about classifying whether a mortgage for a house or property as an investment or not is whether you are truly IN LOVE with the property. People fail to consider the possibilities that in 20 or 30 years the area surrounding the property can and does change: rezoning, urban development, a good neighborhood becoming unsafe, etc. Those things affect the value of such property (or worse, make the property unlivable). It is always better to pay for a property in cash because you can sell it off faster than having a mortgage and jumping through hoops with a bank and realtors. I have seen some home owners trying to get a second mortgage for a second house just to rent the first one for extra income. I think those people are nuts.
save. spend. splurge.
Can you imagine the headache of two mortgages let alone one?!
Gia T.
I agree with you on all points. It’s just not a form of savings. I also go one further and don’t really think of it as an investment, unless it’s generating funds for me right now in the form of rental income.
Yes, in 10, 20, 30 years a house may have appreciated in value, and my initial investment would have grown, but I don’t really want to count on that because so much can happen (it burns down, we need to sell and it’s underwater, etc.). I want a house so I can put a roof over my family’s head, and if it goes up in value, that’s gravy.
save. spend. splurge.
It’d be a slight investment or a way to hedge a bet that it will be cheaper than renting in the long term. Once you have a home, you clear the mortgage and rent is cheaper
I know that I would pay about $400 a month in “rent” once a condo is paid off versus $2700 for a similar place.
SP
Hmm… I think it isn’t black & white. It doesn’t make sense that when you owe $10k on your house, you are no better off than if you owe $100k from a “savings” perspective, then suddenly you have lots of savings once you pay off the mortgage. Home equity is real equity, although less liquid. Paying towards interest, obviously, has no impact on savings. It is equivalent to paying rent.
You can sell your home just as easily when the bank owns part of it as when you own it outright. No, you can’t sell half a house, but why would you need to? You sell the whole house, and as long as you have equity, you WILL get the money you paid in principle back. If the value drops, then you don’t. If you own more than the value minus mortgage, you don’t have any equity.
So, it isn’t exactly savings, but it is building equity and wealth. Maybe not the BEST way to build wealth, but it is a way.
save. spend. splurge.
See that’s where the crux of it all lies — if the value drops, you don’t get back any money and you still owe the debt to the bank ( the mortgage ) because the house you sold, couldn’t clear the debt you originally got from the bank.
Emily @ Urban Departures
I don’t consider mortgage repayment “savings” per se. To me “savings” is defined as parking cash aside in a safe, liquid place- which I’m not doing when paying for a mortgage. However, my mortgage repayments are investments; the amount towards my principal increases my assets. Whether or not it’s the smartest form of investment is debatable and circumstance dependent, but similar to purchasing of fund and stocks, it’s subject to market conditions and the investment may generate a return over time. The bank also doesn’t “own” my home equity. If I was to sell today, even with the mortgage unpaid, I own what I’ve put towards my principal and any gains from the resale value, if any.
save. spend. splurge.
And if you had to sell below the amount of the mortgage you owe? You’d end up with debt, yes? So you’re in the negative.
MattNY
I think a mortgage could be an investment if the estimated rate of increase in the value of the property is greater than the interest rate of the mortgage. Also,but unlikely, is if the rate of inflation is higher than the mortgage rate.
Both of those scenarios will probably be beaten out by low cost index funds.
Some people use mortgages as an enforced savings plan, but if they are a shopping addict, they will usually find another way to bankrupt themselves.
save. spend. splurge.
For me it’s more that it’s like buying stocks on margin. You’re borrowing cash to purchase something that you think in the future will increase in value. That’s a bet. I’d rather have the cash on hand to buy something that I know I paid for and I don’t have to owe anyone or take that particular risk.
AdinaJ
I’ll preface my comment by saying that I have a mortgage, so I’m somewhat biased in favour of home ownership (in the right circumstances).
I don’t think a mortgage is a form of saving, but it is strategic spending (or strategic debt, if you prefer) if you do it smartly. A portion of my mortgage payment is money I would spend anyway on renting a house (I have a family, so I can’t do a roommate situation, etc.), and the remainder is, like, a bonus I pay for the privilege of having a very, very hands off “landlord”. Unless I miss a few payments (or decide to burn down my house or something) the bank won’t get involved in my day to day decisions regarding the house. Personally,that’s a bonus, but some people may prefer having a landlord deal with stuff like maintenance. To each their own. At the end, when my mortgage is paid off, my living expenses will decrease AND I will have an asset. To me, that makes it different than straight up consumer debt/spending, which doesn’t help to (one day) decrease my expenses nor leaves me with an asset (as opposed to a consumable good of some sort).
And I just want to add: the bank doesn’t “own” my house. It owns the mortgage. I own the equity, and it’s not an insubstantial portion of the total. As long as you don’t buy over-priced real estate, and pay down your mortgage quickly, you will likely never be in a position where the bank actually owns your house. That rhetoric is as overblown as saying that you’re throwing money out of the window if you rent 😉
save. spend. splurge.
Ugh roommates. I hated having roommates.
So my problem with the bank owning the mortgage that you have on the house, is if they interest rates rise (and very likely they will), and people default on the payments, then can’t sell the house to even clear the debt (not to mention the fees for the real estate agent and so on), is it really any better off? You’re back to zero.
Kassandra @ More Than Just Money
I agree with your points and a paying mortgage is servicing a debt. It’s no different that monthly payments on buying a car except of course the depreciation/value of the car once it’s been paid off. Yes the home is yours free and clear once the mortgage is paid off but forced savings I don’t buy into. True forced savings is saving the money and paying for a home in cash like what you’re planning to do!
save. spend. splurge.
Between sticking it in index funds / bank account and putting it in a house with a mortgage, the risk of interest rates going up, maintenance SNAFUs and so on, I’d rather just have everything liquid or fully paid for.
Jordann
Your house is an asset, your mortgage is a liability. Paying down your mortgage isn’t saving, it’s paying off debt! I agree with you, mortgage debt is debt, and like all other debt, should be eliminated as quickly as possible.
This is something I struggle with, because I really want to become a homeowner, but I really don’t want to go back into debt or just put 5% down. That means I’ve got a long road of saving ahead of me.
save. spend. splurge.
A mortgage and a house is a bet that your home will be worth more in the future, and without interest rates rising and taking more of what you pay each month.
Taylor Lee
I agree with Potato, I would definitely consider principle repayment (though illiquid) a form of savings. In addition, buying a house hedges against increases in further housing costs, and so can also induce savings (once a mortgage is paid off, relative to the ever-increasing prices of housing) in addition to being a form of savings.
save. spend. splurge.
Which is what makes it such an awkward investment for me.
Alicia
I think the tricky distinction most people are overlooking is common usage of terms. I think a lot of people think of principal payments as a mortgage as “savings” is because that’s the term in their vernacular. What they really mean is “I own a slightly larger piece of the assets associated with that liability (aka the mortgage)”.
save. spend. splurge.
Good distinction.
Clarisse @ Make Money Your Way
I totally agree with you that mortgage is definitely not a form of savings, but it is indeed a big debt! It will be a savings unless you already full paid and the bank will no longer hold it.
save. spend. splurge.
Or at least have their paws out of your pockets.
Money Pincher
The husband originally bought a 1 bedroom apartment for $149,000 in downtown Vancouver and sold the apartment for about $440,000 after living in it for 10 years. That means, if he were to buy the apartment in cash, he would need to save about $44,000 a year in order to purchase it if he waited until he had enough cash to buy a place. It would be pretty impossible to purchase a place in cash in Vancouver because the price of housing has gone up exponentially the past 10 years.
So, I do think mortgage is a form of saving if you did not max out your mortgage and that if the housing market doesn’t crash, but that’s a risk one needs to take. Once the mortgage is paid off, I own the house. I no longer need to pay any money to roof over my head, except for the annual property tax and regular maintenance of the house. When I retire, I can either sell the house (hopefully at a time when the market is doing well) and downsize and keep the extra cash in the bank (and I don’t need to pay capital gains from it because it was my principal residence).
In the ideal world: once I pay off the house, I can take out another mortgage from the house and use that money to buy and other property (house or apartment) and rent that other property out and use the rental income to pay off the mortgage, so that by the time I retire, I can have the option to either rent out or sell both properties OR I can sell the house (my principal residence) and live in the other property (most likely an apartment).
save. spend. splurge.
At least he sold it! But it could have gone the other way ($149 down to $50?)
It’s a risk I guess I am not interested in taking because it feels like I am trading in a margin account. I like the idea of hedging my future rent by buying a place (I am not against buying a home at all), but I just want everyone to be clear on what a mortgage IS and ISN’T.
It’s like people think paying towards a mortgage = all cash in their pocket. It’s not.
Potato
I think principal repayment is a form of savings: eventually you’ll pay down all the principal and that will provide you a benefit in reduced (but not free — remember that the mortgage is just one portion of total cost of ownership) housing costs. If you sell sooner, you’ll have some left after paying the remaining balance (and fees, and assuming you’re not underwater). So yeah, if I was making a net worth statement, paying down the principal would go to the assets side like savings.
But I’ll echo you that it’s not “high quality” savings. You can’t quickly get access to it in an emergency, etc.
save. spend. splurge.
Then you have to also incur fees to sell the place.. worry about interest rates rising and eating into your payments..
Stephanie
I agree with your article, especially since interest rates on mortgages in the US have been over 10% in the past! Which is a lot of money! And I believe that financials categorize mortgage as a type of debt, so I never really understood why some people don’t see it that way. But it’s a debt that many people find practical. After all, buying a home is about more than just the investment.
But, while you have a mortgage, you can do things to your house (like build a new room, repaint, etc.) that you wouldn’t normally get to do to things that you don’t own. So in that non-financial sense, the house is yours.
Daisy
@Stephanie: Often, buying a home isn’t even an investment, especially in some of the larger cities in Canada. I completely agree that a home is so much more than something to spend money on, so much more than an investment or, in many cases, a bad investment.
save. spend. splurge.
Canada is a scam. A SCAM.
save. spend. splurge.
True…. the house is “yours”.. until the price goes down and you’re desperate to unload it.