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Posted by GJ on July 16, 2007, 3:08 pm
Is it possible to create a formula (or is there an existing source) to
determine the monetary advantages of the mortgage/cash decision of
purchasing a home.
I'm not interested in the emotional issues or the security issues, I would
like to be able to use known values and assumed variables to project each of
the options over time.
Thanks
JW
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Posted by on July 16, 2007, 7:33 pm
> Is it possible to create a formula (or is there an existing source) to
> determine the monetary advantages of the mortgage/cash decision of
> purchasing a home.
The only way to answer is A better than B is to work out both in
excrutiating detail. Taxes are complicated by the progressive rates
and the AMT.
So let's look at a simple case.
MR = Mortgage rate (e.g. .08)
IR = Investment Rate(e.g. .08)
TR = Tax Rate (e.g. .25)
ATR = After Tax Rate
ATR = MR(1-TR)
ATR = IR(1-TR)
So if the same tax rate applies you can directly compare Mortgage Rate
to Investment Rate.
But if you are clever an put your money in a Roth IRA instead of a
taxable account, then the two Tax Rates are not the same. You get a
mortgage which is tax deductible and put the money in a Roth tax
(earnings) free acount.
Or there is the difference between long term capital gains and
ordinary income (TR could be either).
Other considerations.
Real estate varies widelyby state.
In California Purchase Money Mortgages are tax deductible and usually
non-recourse (to deficiency judgement) loans.
Cash out Refi's and HELOCs are only tax deductible upto 100K (above
original basis) and are usually recourse loans.
Always consult a CPA before making a final decision.
Good Luck!
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Posted by joetaxpayer on July 16, 2007, 8:43 pm
GJ wrote:
> Is it possible to create a formula (or is there an existing source) to
> determine the monetary advantages of the mortgage/cash decision of
> purchasing a home.
> I'm not interested in the emotional issues or the security issues, I would
> like to be able to use known values and assumed variables to project each of
> the options over time.
>
> Thanks
> JW
No emotion. First, you want a downpayment large enough to avoid PMI,
which is expensive compared to the money down which will avoid it.
If you can put 30% down instead of 20%, the question quickly turns to
what other assets you have available, you don't want to deplete all
liquidity. Consider that a mortgage is likely the cheapest money you
will ever come across, so before using cash to increase the downpayment
(or alternately, paying down the mortgage faster than the term), I'd
choose to; pay any/all other debt, credit cards, car loan, etc. Fund the
Roth account for you and the spouse, fund the 401(k) past matching if
the expenses are reasonable. Then, look at your after tax cost of the
loan. In the 28% bracket, a 6% mortgage costs you 4.32%. At 15% cap gain
rate, you need a return of 5.08% to break even.
So long as you are working, and already in itemized deduction land (for
some people, much of their mortgage interest goes to first helping to
cover the standard deduction, so it's not really 100% deductible.) this
last equation should help that decision.
The known values are your interest rate, and current tax bracket,
assumed variable would be the market return in your chosen investment.
The larger unknown is the tax structure any year but 2007. The cap gain
rate may go away, so my equation may go out the window, and 6% may
become the break-even.
JOE
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Posted by Will Trice on July 16, 2007, 9:29 pm
joetaxpayer wrote:
> First, you want a downpayment large enough to avoid PMI,
> which is expensive compared to the money down which will avoid it.
You could also take out a second mortgage to avoid PMI. This can make
sense if the interest rate on the second mortgage is low enough. It can
also make sense to go ahead and pay the PMI depending on the interest
rates involved if you're looking strictly at the numbers (I'm ducking
now...).
-Will
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Posted by joetaxpayer on July 16, 2007, 11:41 pm
Will Trice wrote:
> joetaxpayer wrote:
>
>> First, you want a downpayment large enough to avoid PMI,
>> which is expensive compared to the money down which will avoid it.
>
>
> You could also take out a second mortgage to avoid PMI. This can make
> sense if the interest rate on the second mortgage is low enough. It can
> also make sense to go ahead and pay the PMI depending on the interest
> rates involved if you're looking strictly at the numbers (I'm ducking
> now...).
No need to duck, you're right. It seems to answer OP's question
completely I should have stuck to a decision process comparing the most
expensive part of the mortgage, i.e. either the final amount and its
PMI, or the interest rate on the second mortgage, to the other returns
he might experience. I may have been injecting my own issues of risk
aversion in my response.
JOE
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