Figuring out whether you should take out a mortgage isn’t always straightforward. There’s a lot to consider.
Mortgages are the key to a home of your own. But they are also expensive. Plus, you need to lock yourself into an agreement with creditors that could last decades. While you can try paying off a mortgage in less than ten years, many people continue paying for much longer than that.
So, should you take out a mortgage? Let’s look at some of the pros and cons to help you make a decision.
Pros Of Mortgages
This section looks at the pros of taking out a mortgage.
You’ll Finally Own Your Own Home
Taking out a mortgage means you’ll finally own your own home. You’ll no longer need to flush money down the toilet by renting. Any price appreciation is yours to keep.
Strictly speaking, you won’t own it outright. You will have some equity from the deposit and the bank will own the rest. However, you will have a foothold and many more rights over how you manage your home compared to rented accommodation.
For instance, if you want to redecorate, add an extension, or renovate, you can. You can also invite people over whenever you want, get new furniture, and adapt it to your personal tastes. It’s entirely up to you.
You Might Benefit From Tax Perks
Another benefit of taking out a mortgage is tax perks. In many countries, mortgage interest payments are tax-deductible, meaning you can pay them out of gross income instead of net income. This frees up more money for you, allowing you to take more control over your financial situation.
Double-check with your accountant or financial advisor about whether you can make these deductions. These may only apply if you own properties in a company capacity.
You Force Yourself To Save
Paying a mortgage is also a form of forced savings, which can be helpful for some people who struggle to manage their finances. You have to automatically pay for your mortgage every month, whether you want to or not, encouraging you to build equity and wealth over time in your property.
If you struggle with payments, ensure your mortgage is the first thing that goes out every month after your employer pays you. Remember, money towards your mortgage lets you build equity in your home, which is the same as building wealth. Once you own your property outright, you can eliminate direct housing costs entirely and live in your accommodation for free.
Forced savings instill discipline. It is an excellent option if you struggled to save and invest consistently in the past.
Mortgages can also help you benefit from capital appreciation. While you paid a fixed sum for your property, the price of your house is likely to rise substantially over time, in line with secular trends. Property prices rise in line with inflation plus demand, meaning you could get back significantly more than you put in when you sell.
Property appreciation can be dramatic in some areas. You could sell your property if you see an opportunity to make profits and pocket the difference by relocating to another area where prices are still low.
Finally, fixed-rate mortgages offer stable payments. In other words, how much you pay every month doesn’t change from month to month.
This predictability can be helpful. It assists with budgeting and ensures that you know what your outgoings are going to be.
Cons Of Mortgages
Of course, mortgages come with various cons. The downsides can be considerable if you make the wrong decisions.
The Financial Commitment
For starters, mortgages require a substantial financial commitment. You need to be ready for the long haul, often multiple decades. The average mortgage is between 25 and 30 years. That means if you start paying when you are 30, you won’t finish until you are 60, which is most of your working career.
During that time, all sorts of things will happen. Careers will shift, financial situations will move, and you could find yourself unable to meet payments sometimes without dipping into savings. You might also suffer from higher interest rates if you use a variable mortgage or remortgage a fixed rate to a higher rate.
Some people have stable careers that serve them for decades, but these individuals are rare. Because of this, mortgages can become a burden for many working families dealing with turbulent economic circumstances.
The Interest Payments
Another significant downside of mortgages is interest payments. Many people wind up paying more in interest than the value of their homes when they take out long-term mortgages.
For example, you could easily pay back $250,000 on a $100,000 mortgage over thirty years because of interest. This means that longer mortgages are more of a service than “forced savings” where you pay extra fees for the privilege of owning a property that’s larger than what you can afford.
This problem is even worse when interest rates are higher, as they are now. When rates rise linearly, interest payments balloon geometrically. That’s because the total future value of the interest is based on the proportion of the principal paid back in any given repayment period. The less principal repaid, the higher the interest charged on all subsequent payments.
The High Upfront Costs
High upfront costs are another significant downside of mortgages. Buyers often have to pay for the privilege of being loaned money, which doesn’t happen in any other market. That’s because lenders charge a fee to set people up on mortgage products.
Moreover, this payment isn’t small. It can be thousands of dollars, depending on who you go to.
You can avoid these costs, but you often pay through it through different channels, such as higher interest rates. Instead of charging an upfront fee, lenders bolt their costs onto existing products.
You also have to pay a raft of additional costs, including closing costs, inspection fees, and appraisals. These add what economists call “friction” to the transaction, creating a barrier to investing in your property. You have to want to do it.
Finally, you have to save for a downpayment. This lump of capital needs to sometimes be as much as 25 percent of the value of the home, which is substantial. It can take years to save for it.
Another downside is market fluctuations. Instability in the real estate market can mean that properties fall in price, leading you into negative equity territory.
When this happens, banks start to get jittery. Negative equity means that debt on the property is larger than its value, meaning that if you stop making payments and the bank sells the home, they can’t recoup their losses.
This effect can damage your personal balance sheet. A fall in real estate values cuts into your equity and prevents you from building wealth in your home. This is the flipside of appreciation where your home grows in value, and a risk all property owners must take.
You Have Less Flexibility
Mortgages also make your life less flexible. You can’t move location or change careers as easily when you have to pay off a giant loan every month.
Real estate is an illiquid asset. That means that you can’t sell it immediately (unless you are willing to accept a substantial discount). What’s more, selling also costs a lot of money, usually several months’ salary, pushing up the price further. Some property sales can take months to complete.
What To Consider When Taking Out A Mortgage
Whether you take out a mortgage is a deeply personal financial decision. It depends on various factors. Obviously, people do take out these products, but you need to work out whether it is worth it in your situation.
Think about your personal financial situation. Look at your savings, income, and stability. Ask whether you can continue paying your mortgage long-term. Check if you can comfortably afford payments and what might happen if you suddenly lose your job.
Also, take a look at current market conditions. Check the interest rate and ask whether you think it will continue to rise, putting up your monthly costs. Recently, interest rates have been historically high to combat inflation. That’s putting pressure on household budgets and making it harder for people to pay their mortgages on time.
You should also consider your future plans. It might not be worth taking out a mortgage if you only plan on living in an area for a year or two. The transaction costs associated with buying a house, setting up a mortgage, and then selling the house could be prohibitive.
Finally, you’ll want to take a look at the loan terms in the small print. Mortgages tend to be different from other lending products, with complicated clauses and interest rate rules. You might have to pay additional fees if you want to alter your mortgage or pay it off early. You might also be locked into payments for up to 48 months without the opportunity to change the terms with the lender.