Money, like ice cream, has been put on the face of the earth for us to enjoy.Yes, I said enjoy. You go to school, you study hard, and then hopefully you graduate and establish a practice. You work hard to get the practice going, and then you work hard to keep it going. You work hard so you should be able to enjoy the fruits of your labor.
Now don't get me wrong, I am not advocating that you run out on day one and purchase a new Mercedes, $1,000 suits, a million dollar house, and a gold Rollex, all mortgaged to the hilt. I am also not professing that you must stash all of your money away while you live in a one-room bungalow, drive a ten-year-old Ford Escort, and keep your old Timex you've had since high school. Yes, they may all be debt-free, but is that all you want out of life? I see no problem with being debt free, but I also see no problem with taking full advantage of all of the tax breaks that Uncle Sam gives us.
A mortgage is not a terrible thing, if you don't mind the thought of it. The call should be yours. Let's examine the alternatives using Dr. A and Dr. B as our examples.
Dr. A has always been told that it's best to be debt free, so to him a mortgage is bad. He works hard to pay off his mortgage as quickly as possible. No more payments and, better yet, no more interest payments. What a relief.
Dr. B, however, finances his home with a 30-year mortgage and works hard to build equity in other areas that are sheltered from current taxation. He also gets a current tax deduction for the interest payment on his mortgage. Dr. B's interest rate is 9.5% fixed, and pays federal taxes at the top bracket of 31%. This brings his after-tax cost of his mortgage rate down to only 6.5%. His current investments are made on a pre-tax basis, so that he can put away $1,000 and it only cost him, out of pocket, $690. He earns only 8.5% on that money which yields $85 per year. That $85 is also sheltered from current taxation. Dr. B's return is actually greater than 8.5% since the "net" amount invested is only $690. An $85 return on $690 is equal to a return of 12.3%. To equal a 12.3% return in after-tax dollars, you would have to earn a gross of 18%. Needless to say, Dr. B is very happy with his situation.
Appreciation of homes recently has been, at best, very poor. Most areas of the country have posted large losses in home values, so if you had a home with no mortgage, your "investment" in that home posted a loss. Yes, your investment in your home does appreciate on a tax-deferred basis, but tax deferred or not, a loss is still a loss. It is also true that most investments in general have not been so glowing as of late.
Now we come to the real question at hand. Which doctor is right? Will it be Dr. A or Dr. B? Which did you pick? Dr. A or Dr. B? Was your decision based on just the net return of both or on their basic philosophies of debt vs. no debt? I would argue that they both are right, if they are doing what they want to do. "Comfort level" is what it's called. There are people who simply feel more comfortable owning their home outright, and for them the psychological benefits make paying off the loan worthwhile, assuming that they have the funds to do so without hardship.
Here are some additional points for you to consider while you draw your own conclusion on which doctor is correct. Your mortgage is the cheapest money you will ever buy. Mortgage money is in the 10% range today and the interest is still fully deductible. Compare that to other dollars you purchase. Credit card dollars can cost up to 20% and the interest payments are no longer deductible. Auto loans aren't cheap and the interest is not deductible. The median priced home will gain in value at an average rate of less that 5.5% over the next 10 years which will barely keep it above the current inflation rate.
Let's get back to our examples, Dr. A and Dr. B. Before you make your final decision I would like for you to take this little quiz:
- Am I taking full advantage of all of the tax breaks allowed by law?
- Have I at least explored to see what is available to me?
- Have I considered the use of a qualified retirement program?
- Am I trying to shelter money from taxes?
- Do I want to have my cake and eat it too?
After you take this little quiz, make your judgment on who you think is right, Dr. A or Dr. B, and drop me a line so I can announce in a future column who won. Who do you think it will be? Dr. A, Dr. B, or you?
Your comments and inquiries may be directed to:
Stanley Greenfield, R.H.U.
7240 Swansong Way
Please include a self-addressed, stamped envelope. Thank you.
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