Dave Ramsey Mortgage suggestion...

[ScrimpAndSave]

So, Dave Ramsey says that you should only get a mortgage that is 25% or less than your monthly take home pay, put 20% down and it must be on a 15 year note. This means, that I shouldn't have a payment above $900 a month for my mortgage. I wonder if the taxes are supposed to be in that total, too?


With this information, I can afford a crack house. Hahaha

[disneysteve]

This is one place where many disagree with DR. It might work in the boonies but it certainly won't work in urban areas.

I'd go with 28% of income toward housing, a 20% downpayment and a 30-year fixed-rate loan.

[ScrimpAndSave]

28% of gross or take home?

[jIM_Ohio]

My mortgage (with taxes and insurance) is about 24% of gross and about 36% of take home. 30 yr fixed at 5.75% and I put 5% down (I have a second mortgage which is included in above totals).

Many here suggest I am pushing the limits far beyond reasonable boundaries. There are tax implications with a mortgage which I have never seen a DR poster or DR himself mention.

For example you are single, making 55k (right). 15% tax bracket caps at $33950.

55k
std deduction is 5700
personal exemption is $3650

55k-(5700+3650)=45650.
This is in 25% tax bracket. Get about $11700 of deductions and you will see your tax picture change considerably.

$11700+5700=$17400 (add the std deduction back in if you itemize so you can see what you need).

If you put 7% into a 401k or similar, reduce above by $3800. If you have a 30 yr fixed mortgage of $250k at 5.25% you will pay $13,000 in interest first year- add that in. If property taxes are $3000 per year add that in. If you have a state tax bill add that in (otherwise there is a table for sales tax where you can add that in- about $1000-1700 probably). You would get 25% of most of above back (15% of the rest).

Then you can contribute to Roth in 15% bracket and take it out at 25%- giving you significant savings. You will also notice your tax refunds skyrocket (talking $3000-$5000) until you adjust withholdings.

Go here for the numbers (like std deduction, bracket limits etc...)
Reference Room

My wife and I earn close to $120k- if you look that is middle of 25% bracket. Yet by time we itemize we are just under 15% bracket cap every time.

As we pay off the mortgage we adjust 401k upwards a percent or two (to keep the AGI low enough for deductions to push us to 15% bracket). I know this can only last so long (401ks have a cap), so I know the Roth is a good deal for us (pay taxes now at 15%, I won't be there long).

[GREENBACK]

That's kind of funny. When I bought my current home I didn't even have a vague idea of who Dave Ramsey was. I put 20% down with a 15 year note and my payments are about 18% of take home.

I live in a somewhat rural area and am amazed at some of the housing prices I see mentioned on this site.

[poundwise]

It is true that situations and locations vary and I'm not going to be an apologist for Dave Ramsey on this issue, however, I do think it strange that everyone just accepts 30 years as the absolute norm for a mortgage.

Have you ever put an amount and a rate in a calculator and seen the difference in what you ultimately pay if you have a 30 year mortgage as opposed to a shorter term?

I used the mortgage loan calculator at Dinkytown.net to come up with the following:

$200,000 - 5.5% - 30 years - $1,136 payment - $208,807 interest
$200,000 - 5.5% - 20 years - $1,376 payment - $130,187 interest
$200,000 - 5.5%- 15 years - $1,634 payment - $94,150 interest

So, for a payment of $500 more per month, you save well over $100k over the life of the loan and own your house 15 years sooner.

If $500 makes the payment out of reach, then consider that a payment of $240 more per month still saves you nearly $80k and 10 years.

When interest rates are higher, the differences grow even larger.

I'm not trying to tell anyone what they should do and I don't have a comment on what percentage of your income you should base your plans on - there are a lot of variables - however, I do think considering the term and the overall cost certainly provides food for thought.

[jIM_Ohio]

Originally Posted by poundwise

It is true that situations and locations vary and I'm not going to be an apologist for Dave Ramsey on this issue, however, I do think it strange that everyone just accepts 30 years as the absolute norm for a mortgage.

Have you ever put an amount and a rate in a calculator and seen the difference in what you ultimately pay if you have a 30 year mortgage as opposed to a shorter term?

I used the mortgage loan calculator at Dinkytown.net to come up with the following:

$200,000 - 5.5% - 30 years - $1,136 payment - $208,807 interest
$200,000 - 5.5% - 20 years - $1,376 payment - $130,187 interest
$200,000 - 5.5%- 15 years - $1,634 payment - $94,150 interest

So, for a payment of $500 more per month, you save well over $100k over the life of the loan and own your house 15 years sooner.

If $500 makes the payment out of reach, then consider that a payment of $240 more per month still saves you nearly $80k and 10 years.

When interest rates are higher, the differences grow even larger.

I'm not trying to tell anyone what they should do and I don't have a comment on what percentage of your income you should base your plans on - there are a lot of variables - however, I do think considering the term and the overall cost certainly provides food for thought.

Consider cash flow on the 30 year. That $500/month difference is a Roth deposit. Invest the $500/month difference for 30 years and see it grow at 7%, you have $600k+ in the investment account.

If you did the 15 year and could not invest until year 16 (and invested the full $1634), you have $527k at end of same 30 year period.

If the return is 9% the 30 year plan has just short of 900k and the 15 year plan has 627k (30 year plan almost 50% more).

two issues here- the 15 year plan would lose more to taxes in two ways:
1) less tax deduction
2) the $1634/mo could not all be invested in a Roth (too high for two spouses limits), so a portion of the return would be lost to taxes too.

**My suggestion would be do 30 year, get the Roth maxed, then look to come back once retirement accounts are on track and pay off the mortgage in 15-20 years**. Retirement planning should come before a 15 year payoff is locked in.

[LivingAlmostLarge]

He's on crack. Seriously, it would never fly in anywhere that is a middle to high COLA. Live in CA, NY, DC, Boston and surrounding areas like NJ, Conn, MD, VA and you couldn't buy a condo for less than $200k. By his numbers the only people affording a 1 bedroom condo for $200k would be making something close to $100k.

Anyway though, there are other factors besides what Jim mentioned, which by the way Jim, I ran as well.

Where are you in your career and family life? Are you a dual income family likely to go to 1 income when you have kids? Then don't buy a home based on two incomes.

Are you beginning your career like my DH and I so buying a house at 28% PITI isn't a huge deal because our incomes have huge upside potential. If I got a job right now, I know our PITI would be around 15%. Buying a home at 40 without much chance of promotions or raises, be more conservative.

But someone just finishing an MD, Phd or other professional degree and buying their first home? If they stretch and buy at 30-35%? It might be a very different story.

As for poundwise, when you are in the upper income brackets, mortgage money is cheap. It's a hedge against inflation and in 30 years when you are still paying your mortgage the rental next door might be 2x the price for rent.

It never makes sense to prepay your mortgage if you aren't taking advanatage of a 401k and IRA maximum contributions for both. Above and beyond, you can make the argument that it's worth paying down the mortgage.

But that's $16.5k for a 401k, around $20k for Roth 401k, $5k for a Roth or non-deductible IRA. That's $20k/year per person.

If you are saving that much per person then pay off the mortgage. If not the tax benefits of the 401k makes it attractive or even a Roth 401k makes it attractive to save instead of paying off a 6%, 30 year fixed mortgage which migh only have an EFFECTIVE tax rate of 4.5%.

People who say get a 15 year versus 30 year and only look at the interest paid out, are NOT running the numbers. They aren't looking at what happens if they put every penny they paid into a 401k/IRA. They are not looking at the tax break for the 401k.

Basically it's short sighted. But it makes people feel good. So it's fine. But at the end of the day they are poorer than people who hang onto mortgages and invest the difference. They are richer than those who don't prepay the mortgage. But which category do you want to be in?

Rich, comfortable or broke? I'm aiming to be rich.

[disneysteve]

Originally Posted by poundwise

I do think it strange that everyone just accepts 30 years as the absolute norm for a mortgage.

Have you ever put an amount and a rate in a calculator and seen the difference in what you ultimately pay if you have a 30 year mortgage as opposed to a shorter term?

You're assuming that taking a 30-year mortgage means keeping it for 30 years. Very few people take 30 years to pay off their loans. Either they move during that time or they accelerate payments. The 30-year loan gives you much more flexibility than the 15-year loan. There is nothing stopping you from getting a 30 and paying it off in 15 or 18 or 22. Whatever works for you. With the 15, you are locked into that higher payment. If anything changes in your financial situation, you're stuck. With the 30, you have the flexibility to make higher payments but if other needs arise, you can drop back to the lower scheduled payment.

Plus, as Jim pointed out, you generally come out ahead by taking the longer loan and investing the difference.

[jIM_Ohio]

Plus, as Jim pointed out, you generally come out ahead by taking the longer loan and investing the difference.

at todays historically low mortgage rates

[ScrimpAndSave]

Yeah that is the problem, too. I don't know whether or not I will be able to take advantage of these "historically low rates" because I probably won't buy until the end of the year. I feel like moving in the summer would be a gamble because I will only have around $25,000-$30,000 saved and that would take some creative financing to get something. Waiting until the end of the year will be better because I will have (hopefully) close to $45,000...and I am also hoping that interest rates won't skyrocket or do anything crazy by then.

[disneysteve]

Originally Posted by ScrimpAndSave

I don't know whether or not I will be able to take advantage of these "historically low rates"

Unfortunately, you can't worry about that. Don't let the rates push you into doing something that you aren't financially (or emotionally) ready to do.

[Gruntina]

We pay 36% towards our mortgage. Granted this is coming from take home pay that does not factor in the 401k, medical, FSA and etc that are taken out pre taxed. We also do not carry credit card debts either.

While we are homebodies type and live in the SF Bay area where we do not need to travel much for vacations since there is so much to do and see within the area, I am finding that paying 36% is still not really ideal. If the house didn't need major renovation, then it’s very doable. We need to fix the foundations and driveway which will take time to save up for.

If you can find a house that will need minimal repairs, then you probably do well on 25% take home pay. But if the house you get will need major repairs or renovation, it will be tougher.

[MonkeyMama]

Good points.

1st home - crazy HCOLA - 8%+ interest rates - 30 years. But since DINKS, refied quickly to 15-year. Lower rates were a factor.

We actually went to a 30-year loan for many years, less by choice, more due to other factors (having 2 homes; dropping one income, etc). We started talking about going back to 15-year, or at least making that a goal, in 2008. Decided not interested. Still have the urge to pay off in 15 years, just not to tie myself down to the higher payment. Too much life has happened the last decade. I'd do a 15-year if you could guarantee I wouldn't get very sick or laid off or anything for 15 years. Have come to prefer the flexibility of a 30-year. We are young enough, we are far better off to beef up our ROTHs.

Also, we just refied to below 5%. No interest in paying down right now. Investing to beat 5% is pretty guaranteed.

Age, region, job outlook, and interest rates are all important variables.

Our personal goal, assuming good health and prosperity, is to pay off 20 years from OP of current home. Kids added 5 years; lost income and increased expenses.

BTW, first mortgage at age 22 was 20% down, probably 36% debt to income. Today at age 31, mortgage is only 15% of gross (one income at that). 36% may have been high, but it was considerably cheaper than renting. THat is why we bought so young. But we grew into it quickly. (higher income, lower interest rates). I expect decent income in the future. If nothing else, dh's $0 income has considerable room for growth; we're still quite young. I am not sure I'd advise 36% debt to income ratio at 40. Nor at the height of one's career...

[Gruntina]

I forgot to add - we always pay 10% tithe base on our gross earnings. Our disposable incomes is smaller after the tithe has been paid. So in that aspect is probably why we have harder time saving large sums of money in a shorter time.

[poundwise]

I recognize the points mentioned and understand their merits. Honestly, the replies above include those from people I consider to be quite smart and among the best members here when it comes to certain advice.

And, before I continue, I should note that I am not attempting to make hard arguments here. I am being a bit purposefully contrarian.

Having said that...

While it is true that most people don't keep 30 year mortgages for 30 years, this is mostly attributable to people moving (which was mentioned), not people paying their mortgages off early. When people who have a house and 30 year mortgage move, what do they typically do? Buy another house, with a brand new 30 year mortgage. If I have a house and a 30 year mortgage, and I live there 10 years and move to a similar COLA, why is it that I should restart at 30 again? Wouldn't a 20 suffice to give me approximately the same payment and same term I had when I began to build equity?

Also, I certainly understand opportunity costs. However, in the example cited, a person earns 7% per year. That average is absolutely attainable, however, there is the possibility of earning more or less, including considerably more or considerably less. The person who pays the 5.5% mortgage saves 5.5% guaranteed. Also, the example breaks out a calculation of the payment difference invested based on 30 years. It is important to remember that the comparison isn't between two people who each pay on a mortgage for 30 years, with one having a $500 less payment that he invests while the other does not. That is, consider that the one person has $500 more that he invests for 15 years, while the other does not. Then, for the next 15 years, the first party has the same $500 and the same mortgage payment, while the second party now has the total of his entire mortgage payment to save/invest for the next 15 years. I also understand the value of investing early and consistently, so don't think I fail to recognize that. However, the fact is, you have to consider the value of the second 15 year period, with a paid-for house and no mortgage payment, when making the comparison in order to have more of an apples to apples look.

There is also something to be said for owning your own house outright when it comes time to retire. The same can be true for the person who becomes disabled during their working lifetime, or a person who loses their spouse. Again, I know that there are other things like long-term disability and life insurance that we use to attempt to account for these things, however, you have to follow even that out to its end to get a fair comparison. If you become disabled, you will not have as much income as you did before and will not likely have the same opportunity to increase your income as before. Wouldn't it be nice, in that situation, to have a paid-for house? Or, at worst, a mortgage with 2 years left rather 17? Similarly, you may have a $110k left on your mortgage when you die. Your spouse receives the proceeds from your $250k life insurance policy and, with everything else you've done in preparation, he or she will be just fine. However, it is still quite a different picture if they receive those same proceeds and yet have no mortgage. (Or if you outlive your policy, but not your mortgage. Or if you aren't adequately insured, etc.)

Ultimately, all of that is just what I said it was before, food for thought. The one point I will stand behind more firmly is the comparison of the 30 year with the 20 year. In the example I provided earlier, with a rate of 5.5%, for the relatively small sum of $240/month, a person knocks of $80k and 10 years from their mortgage. That's a point worth attention.

Allow me to state one last time - in an attempt to keep the flames away - I understand all that has been said in contrast to my comments and recognize the truth and value to those statements. Prevailing wisdom is often such for a reason. However, I also believe that what is 'commonly done' is not always what is best. There are a lot of 'smart' people with a plan that will be struggling in retirement with 18 years left on a mortgage and their 'smart' student loan (that's another topic, I know), from 35 years ago, still owing.

In conclusion, and for the record, I presently rent. When I buy, my current view is that I intend to apply between 10% and 20% down and to seek a 20 year mortgage.

[gamecock43]

I gotta be honest- my financial education has advanced a bit because I have "read" this argument many times in the past but today was actually the first time I understood it! I'm proud of that accomplishment alone.

BB and I were planning to pay an extra $100 a month to our 30yr mortgage, shaving off about 10 yrs. poundwises' argument made me realize I might as well get a 20 yr mortgage then and get the benefit of a lower interest rate. Then Jim talked me back into a 30 yr mortgage with no prepayment and instead invest the $100 a month! I'm not sure what we're gonna do at this point.

[MonkeyMama]

I think at face value I agree with your feeling poundwise. Not necessarily the means, but I think mostly we agree.

I think we disagree on factors. If I don't prepay a dime of my mortgage it will be paid off well before retirement. I don't think it's wise to have a mortgage in retirement. But 30 years does not equal mortgage in retirement. If we never refied or bought up, house would have been paid off age 52. (Age is a factor).

I think our personal choice was to put a little more down and have lower payments. We actually put 25% down on our current home. Which I do think few agree with, but I wouldn't do it any other way.

HCOLA is a whole other ball of wax. I could care less about the cost of a mortgage for 30 years. Fact is, some day it will be paid off. Most of our friends rent half the house for a rent payment double our mortgage.

If something happened to my spouse the last thing I would do is tie up the insurance money on paying the mortgage. We have a reasonable payment either of us could afford. I can't say the same if we had a 15-year mortgage. Not at all. (I think this is my most important point here).

It's a balance between payments and liquidity. I like the balance we have struck. But different circumstances mean different results. Your plan is probably best balance for you. Nothing to say about that. (We both have a 20-year plan; I believe mine is more flexible. But I think yeah, we are mostly on the same page).

I also think most people over value the security of a paid off house. Retirement is a far safer place to park your money. No one can get at your retirement for anything. People can take your house (bankruptcy, lawsuit, etc.). A house is more protected than most assets, but retirement assets are like an impenetrable fortress. There is just no comparison.

[LivingAlmostLarge]

You are missing out poundwise on the tax break for the mortgage and the tax break from the 401k. Your calculations are flawed. You cannot talk about a 5.5% mortgage without calculating the tax break.

You cannot talk about investing the extra money without talking about the tax break. Thus the argument youare making about paying less interest cannot be real unless you factor in these things.

I get paying it off to feel good, and resetting the mortgage clock. I've done that, and I probably will get a 30 year fixed again next time. But I plan on making sure no matter what happens I'm saving all my retirement options 100%, then ESPP (15% discount) if offered, then my mortgage.

So everything I can get a break on, I will.

By the way saving 25% on $1 I put into my 401k instead of my 5.5% mortgage, which one has the higher return? I think 25%. But even at 15% tax break I could be wrong about having save myself 15 cent taxes over 5.5 cents interest. Not counting state income tax break.

Realize I pay 5% state income taxes. If I so fortunately move one day to a state with no income taxes (hello washington), I'll never pay state income taxes on that retirement money! Cha-ching.

So whose farther ahead? And that 5% state income taxes negates my 5.5% mortgage, which is actually only 4.25% or so.

[gamecock43]

Is it possible that this argument is for two separate sets of people? I have heard that Americans save some ridiculously low amount towards retirement (like 4% or something), and are in debt a ridiculously high amount. So in general, for AMERICANS, its best to prepay the mortgage as a forced savings account, raise consciousness of numbers and money in general and to reduce debt.

But for SA members...things are different because members of this forum tend to try already be on the path to reducing debt, stretching their dollars, and find the most efficient, productive use of their money.

just an idea.