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Get the biggest 30-year, fixed-rate mortgage on your home that you can safely afford.

Posted by John Reed on

The National Housing Council sent me a news release that I think is incorrect by incompleteness.
They are basically unhappy about the interest expense on a new first mortgage being much greater than the rate on their existing first mortgage. They prefer that you get a home equity second mortgage thereby preserving a likely lower interest rate of about 3% on your existing first mortgage.
They acknowledge that the rate on home equity loans is higher than on new firsts. They also admit the term is shorter like ten years instead of 30. They did NOT mention that HELOCs often have not only higher rates but floating rates that can go even higher than they start.
The huge omission is inflation. During inflation, the REAL (adjusted for inflation) interest rate is the nominal rate (now around 6.5%) minus the inflation rate (most recently 6.04%) leaving a REAL rate of 6.5% - 6.04% = .46%.
That is a LOW interest rate. More importantly, inflation makes your REAL monthly payment and loan balance fall. That makes your REAL home equity and therefore net worth increase faster than inflation.
During inflation, debtors make out like bandits because inflation makes the REAL amount owed fall. So the greater the amount of fixed-rate debt you owe, the more you profit.
While the basic logic of getting a second mortgage makes sense, the disadvantages are:
• The interest rate on a second is higher than on a new first.
• That interest rate floats according to inflation.
• And the term is much shorter than on a new, 30-year first mortgage. That raises the monthly payment as a percentage of the amount borrowed and it raises the amount of principal you have to pay each month. You may also have a balloon payment which is extremely dangerous. 30-year first mortgages are self-amortizing meaning when you make the 360th payment, the loan is all paid off.
• Mortgage interest may be deductible for you. If so, you need to look only at the after tax cost.
My advice is that you should have the biggest 30-year fixed rate mortgage you can safely afford because inflation causes you to make out like a bandit on the mortgage amount. If you are going to make out like a bandit, you want the “bandit amount” to be as larges as possible. Interest expense avoidance is generally wise, but you must only look at it on an after-tax and after-inflation basis.

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