Because like hell I’m coming up with my own ideas at this point, allow me to steal one from one of the commenters. From the Sean Cooper mortgage debate post:
If this comment isn’t proof smarter than average people hang around here, nothing is. Johnathan has some pretty interesting thoughts. Let’s see what would have happened if we followed his premise.
A few months ago, I wrote a post making fun of millennials bitching about baby boomers. In it, I did a little research and found that the average Canadian house cost $76,214 back in 1984. The five-year mortgage rate was about 13%.
Instead of my going through all the findings individually, let’s look at what a homeowner would have paid in interest over the next 30 years. Remember, they’re not paying a nickel of principal.
Before we go on, a caveat:
I suspect you’d be able to have gotten cheaper mortgages than I listed above. Nobody with functioning grey matter was paying 4.79% in 2014, as an example. The numbers came from the Bank of Canada, which tracks posted rates.
At first glance, it seems pretty expensive. You would have ended up paying more than $200,000 for a house over 31 years, and still owe more than $76,000 on it. You also would have had to pay property taxes, replace the roof and probably the furnace at least once, and so on. We’ll ignore those costs for now, since they would have been borne by anyone who owned the place no matter what they were paying.
Now we have to track the amount of money that normally would have been put towards principal. This table tracks how much money would have been paid towards the mortgage itself during each period. We’ll assume a 25-year payback for each one.
|Years||Cash available to invest|
This doesn’t look very impressive at all. Because we kept extending out the amortization (essentially resetting the loan each time), we’re not paying down the mortgage very quickly. Remember, you basically go nowhere in the first five years.
But what about if we factor in the cost of ownership, which in this case is the monthly payment. But instead of using the total monthly payment, let’s just look at what goes towards interest. Try and act surprised when you see the pattern.
|Years||Interest Only (monthly)|
Now we’re talking. As you can see, the cost to “rent” your average house goes down considerably as interest rates fall. While this is happening, I think we can count on our imaginary person getting raises and having his income go up, which means he’ll have all sorts of additional cash to put away into investments.
One last table. In this one, we’ll assume our homeowner gets a 15% raise every five years. His salary starts at $41,300, which is what the median family earned back when ol’ Nelly was being hatched.
|Years||Monthly Income||Payment||% of Monthly Income|
So as you can see, you’re opening up a huge cash flow gap between what you have to spend on interest and what you earn over the years. The debt burden goes from nearly a quarter of gross salary to what becomes a cheap car payment.
Now that we have the numbers out of the way, let me explain why this wouldn’t have been a good strategy to take on over the last 30 years.
For a decade after taking out the mortgage, you would have been able to get 12-13% guaranteed returns just by paying the thing off. Those are huge, and I guarantee they would have beat any investment in the stock market, especially considering how there are no tax implications. The government isn’t charging you taxes to pay off debt.
Basically, rates have moved in the wrong direction for this to be a very good idea in the last 30 years. Remember, the whole point of the exercise is to get more capital to invest earlier on. This way we do free up money to invest, but not until later on.
But what about today? In 2016, assuming you’re paying under 3%, interest costs are very low. But the price of the average Canadian house has gone from $76,000 to more than $400,000. If you were to try the strategy today, you’d be looking at $11,000 per year of interest payments alone, assuming a 2.75% interest rate.
Rates will probably go up from here, we’re just not certain how much. Thus, the cost to do this each year is bound to go up over time. This should be offset by your wage going up somewhat. Still, I wouldn’t expect the nominal cost of doing this to go down.
I don’t think I’d be comfortable doing an interest-only mortgage for long periods of time. I’d consider it in times rates are very low, but I think I’d also be inclined to periodically throw some money down on the principal.
Of course, there’s a far easier way to do such a move. Since renting in Canada is cheaper than buying just about everywhere, just rent and invest the difference in a basket of equities. And that way, you won’t have to shell out cash for any home improvements, taxes, or anything like that.