We live in scary economic times. Financial institutions that were in business for over 100 years have folded. The banking system has been bailed out by the government. Detroit, once the manufacturing hub of the US is facing close to 20% unemployment. With all this bad news, you may be going through stress and starting to cut expenses.
No doubt you're hearing about the one million people who have lost their house to foreclosure. You've undoubtedly heard stories or read about those that lost their house in the Great Depression. In the 1920's and 1930's at the height of the depression, banks called in loans because they were running out of cash. Imagine having a mortgage and then having it cancelled! Thanks to legislation, banks are no longer permitted to end mortgages early. There was no such thing as unemployment insurance, or loan modifications.
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Take advantage of interest rates
Every month, you think "I wish I could get rid of this mortgage." You could refinance to a 15 year mortgage or make extra payments to pay it off quicker. Conventional wisdom says to retire your mortgage debt as soon as possible. That wisdom worked well in the old days when mortgage rates were 8 to 12% or higher. Given today's economic environment, paying off a mortgage early is a bad idea. If have acquired a mortgage within the last several years and you're comfortable with your payments, you should extend your mortgage as long as possible. Today's interest rates are on sale and at historic lows. You may not see interest rates this low for a very long time, possibly your lifetime.
Real life example
Let's say in round numbers you have a $100,000 mortgage and paying a 6% rate. You are in the 25% tax bracket which will effectively bring your actual interest rate down to around 4.5%. You have put your standard 20% down. You now control $120,000 worth of property with just $20,000 and you're effectively paying 4.5% interest after tax breaks. You've locked in that $120,000 price and interest rate for 30 years. If your salary just keeps pace with historical inflation (3%), you'll be earning twice what you're earning today in 24 years; your mortgage on the other hand will be fixed in today's dollars. Given a very conservative rate of return, at 3%, your home will double in price in 24 years. In addition, you will own your home outright.
According to a George Mason study, over the past 30 years, there has been no nine-year period where the average home price in the metropolitan area has experienced a decline. Home prices have grown, on average, nearly six percent annually or 50 percent over a nine-year period during the past three decades.
Do not make extra payments on your mortgage
Not making extra payments or paying off your mortgage early will afford you other opportunities to open a small business or perhaps invest the extra capital in the stock market. From January 1926 through March 2009 the annualized total return for the S&P 500 was 9.51%. The annualized return consists of both capital appreciation and dividends reinvested. As you can see, it is vital you invest long term and reinvest those dividends.
Should you invest in a simple index mutual fund and earn even an 8% return in an IRA, your money will double in about 9 years. Have a 401k that your employer contributes to? Your money should double even faster.
There have been headlines made of both the general public and billion dollar companies using leverage. Those who have used leverage improperly are now in bankruptcy. Conservatively, your mortgage payment should be no more than 28% of your income.
Take advantage of the current economic situation. Interest rates are at historic lows. Tax rates are on sale as well. While there is no way to predict if Congress will change the tax laws, most political pundits agree that tax rates will have to rise in order to pay for the stimulus bill. Additionally, home prices in many metropolitan areas are now 25-50% or more below their highs.
There is an old adage on Wall Street. "Buy when there's blood in the streets". No one can pin point when the real estate and stock market will make a full recovery. Get educated and read up on the economic conditions during the Great Depression and the mid 70s. You will see some striking comparisons. Your job is to take advantage of today's economy and today's opportunities.
Larry Lane is the editor for InvestorZoo.com, a social networking site specializing in personal finance
The article above is information of a general nature and the information provided may not apply to your personal situation. Please consult your financial planner or licensed professional for investment advice.
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