[Editor's Note: This is Part 3/5 of a critique of Missed Fortune 101, a book by Douglas Andrew.  If you're not coming here from part 2, better go back and read parts 1 and 2 first.]

Putting Money Down Gets You A Cheaper Mortgage

Throughout the book, Douglas continually shows you illustrations where the mortgage rate is the same no matter how much you put down.  That hasn't been my experience when I've been out mortgage shopping.  Putting down more money gives you more options, makes it more likely for you to qualify for a mortgage at all, lowers fees, and reduces the interest rate.  It also lowers your payment, since the loan is smaller, and helps keep you from overbuying, an important behavioral effect.  Taking a look at the Amerisave website as I write this (January 2013) now shows the following:

  • $400K home, 30 year mortgage, 20% down:  3.25%, $1280 in fees
  • $400K home, 30 year mortgage, 10% down: 3.25%, $2630 + $186 per month in mortgage insurance
  • $400K home, 30 year mortgage, 5% down: 3.25%, $2676 in fees + $244 per month in mortgage insurance
  • 0% down loans not available from Amerisave unless you qualify for a VA or USDA loan

Now I don't want the reader to assume that these are the only loan options out there.  Many doctors, for instance, qualify for a 0% down loan that's typically 1/4- 1/2% more expensive than a 20% down conventional loan.  But you can see the trend.  The less you put down, the more you will pay, whether you pay with a higher rate, higher fees, more points, or more in mortgage insurance. Likewise, you would see similar reductions in cost when looking at a shorter loan term compared to a 30 year mortgage.  For example, Amerisave currently advertises this for a 15 year mortgage:

  • $400K home, 15 year mortgage, 20% down: 2.50%, $1046 in fees.

Mr. Andrew fails to account for this factor when making his analyses.  Bad assumptions = incorrect conclusions.  It should be noted that we are in a time of uncharacteristically low interest rates right now.  Under more typical circumstances, the additional costs of not putting money down are quite a bit higher.

Your Mortgage Interest Might Not Be Deductible

Douglas also always assumes that your mortgage interest is 100% deductible.  Remember that in 2013 a married couple gets a standard deduction of $12,200.  To deduct mortgage interest, you have to file schedule A and itemize your deductions.  If you don't have more than $12,200 in deductions, your mortgage interest is completely non-deductible since you're going to be taking the standard deduction anyway.  For your mortgage interest to be completely deductible, you need to have at least $12,200 in OTHER deductions.  Most highly-paid professionals don't take the standard deduction, but 70%+ of Americans do (probably including the couple making $72,000 that Mr. Andrews keeps using as an example in his book.)  How big of a mortgage do you need at today's rate to pay more than $12,200 in interest a year?  $375K.  I hope you're giving a lot to charity or paying a lot of state taxes if you're planning on your mortgage interest being fully deductible.

You Have To Be Foreclosed On To Lose Home Equity

Douglas seems to have this irrational fear of losing home equity in a foreclosure.  He wants to keep it out of the home so he can't lose it to the bank when the bank takes the home.  I understand why he has this fear, since he reveals in the book that he lost his home to foreclosure and lost $150K in equity in his early 20s.  The financial professionals who read this blog tend to have very stable incomes and are rarely foreclosed on, especially if they keep a reasonable emergency fund.  I'm only six years out of residency and my portfolio is already larger than my entire mortgage.  This fear is highly overblown in the book.  Home equity might not be an FDIC-insured bank account, but I certainly wouldn't consider it a risky investment because I could lose the house to the bank.  I'm sorry you lost your house Doug, but perhaps you shouldn't have bought a 6400 square foot house at age 24 on a highly variable income.

You Still Have To Service The Debt

The book suggests you pay lots of that tax-deductible (maybe) mortgage interest because paying mortgage interest is just as good a tax deduction as contributing to a 401K.  But the fact remains that you can stop making $401K contributions at any time if you run into financial trouble.  You still have to make those house payments, or you'll lose the house.  Perhaps Doug doesn't mind losing his houses since he doesn't have any equity in them, but there are serious consequences to a foreclosure, none of which I want to deal with.  First, your credit score gets slaughtered, making it very hard to get any loan at all for 7 years.  Second, you have to uproot your family out of your neighborhood, perhaps leave your church congregation, and pull the kids out of their schools.  Not to mention the costs and hassles of actually moving.  Third, I don't know of anyone who's been through a foreclosure who thought it was a pleasant experience.  It probably isn't as bad as going through a malpractice suit, but it can't be very fun.  The more debt you carry, the more you have to service.  If, as Doug suggests, you have $500K in debt on your main home and another $500K in debt on your second home, that's $1M in debt you have to service every month.  Even if you can get it at say 4%, you still have to come up with $3333 every month to service it.  Sure, $1111 is deductible, but $2222 isn't.  If you think it's a good deal to pay $3 to deduct $1, I'll let you send me $100 every month and I promise to send you $33 back.

As long as we're talking about Mr. Andrew's unfortunate incident in his 20s, why is it that all the financial gurus in Utah seem to have gone bankrupt (or gotten foreclosed on) at least once?  Robert G. Allen and Carl Richards come to mind.  No wonder Lending Club data shows Utah is one of the worst states to lend money in.  Utah also has the fourth highest bankruptcy rate, despite one of the best economies.  Don't get me wrong.  I think it's great that these guys got back on their feet after being knocked down.  But Mr. Andrews advocates that if you want to become a millionaire you should get advice from millionaires.  I say, if you want to be a millionaire and never go bankrupt or get foreclosed on, you should get advice from millionaires who have never gone bankrupt or been foreclosed on, like the Bogleheads, rather than the Utah financial guru/seminar industry.

Paying Down A Mortgage Vs Investing

Mr. Andrew rightly points out that mathematically, there may be many times when you are better off investing than paying down your mortgage, especially a low-rate, fully-deductible one.  (For instance, my after-tax rate on my mortgage this year is 1.7%, less than anticipated inflation.)  But he never mentions the benefits of eliminating debt- improved cash flow, freedom to decrease income, lower fixed expenses, a feeling of financial freedom etc.  Paying down the debt, of course, provides a guaranteed, albeit low, rate of return as mentioned above.  That rate is really little different from the guaranteed rate available with any investment, including universal life insurance, but more about that tomorrow.  Stay tuned.  Part 4 can be found here.