Rule #1: If you’re buying a house, never let a mortgage lender tell you what you can afford
A lender makes more money when you borrow more money. And most lenders don’t really know everything about your finances; they just look at your income and do a quick calculation to tell you what they think you can afford. They don’t know anything about how much you’re saving for retirement or whether you want to help your kids financially with college.
You need to decide what you can afford to buy for yourself, based on your long-term goals. Always remember: The smaller your mortgage, the more money you’ll have for other financial goals.
Rule #3: If you own a home, protect your equity.
I know many of you have seen the value of your home rise a bunch over the past few years, giving you more equity in your home. And many of you have tapped into that equity by taking out a home equity line of credit (HELOC). This is not wise because it converts equity into debt (the HELOC that you must repay). I don’t recommend borrowing against the equity in your home unless it’s for an absolutely necessary expenditure like repairing the roof.
Rule #4: Pay in full.
If you are at least 45 and have no desire to ever move, start paying off your mortgage. The best security move is to get your mortgage paid off before you retire. Just tune out the people who say it doesn’t make sense to give up the valuable tax break that comes with a mortgage-interest deduction.
Most of the interest deductions happen in the early years anyway. Let’s say you have a $200,000, 30-year fixed-rate mortgage at 6 percent. Your monthly payment will be $1,199 a month—or about $14,400 a year—for 30 years. In the early years of the mortgage, you’ll pay mostly interest—at least $11,000 a year—so $11,000 of your $14,400 mortgage payment will be tax deductible. Now let’s jump forward 20 years: Your yearly mortgage payment is still $14,400, but your interest payment will not account for more than about $6,000. The bottom line is that your interest tax deductions decline the longer you pay your mortgage. But we’re not talking just about a tax write-off here: Nothing feels better than owning your home outright.
Besides, your mortgage is probably your largest monthly expense—so, if you get it paid off before you retire, you will have reduced the amount of money on which you’ll need to live during retirement.
Rule #5: Be realistic.
We all know that real estate was on a tear until very recently; in some parts of the country, home values jumped more than 20 percent a year. That is not normal, and it is not sustainable. I want everybody to read this very carefully: Over the long term, you should expect your home’s value to rise at a rate that slightly exceeds inflation. It’s a solid investment, but not one on which you should expect to retire. Don’t think that just because your home’s value has had a great run you don’t need to invest in your EPF. Be better prepared than that.