A mortgage is a loan that the borrower uses to purchase or maintain a home or other form of real estate and agrees to pay back over time, typically in a series of regular payments. The property serves as collateral to secure the loan.
The Census Bureau estimates that in 2019, 62 percent of owner-occupied properties had a mortgage. For the remaining share who have the cash to buy real estate without one — or for those able to pay theirs off — there’s a choice to be made: take on or continue paying a mortgage, or skip it and own your property outright.
KEY TAKEAWAYS
- Mortgages are loans that are used to buy homes and other real estate.
- The property itself serves as collateral for the loan
- Mortgages are available in a variety of types, including fixed-rate and adjustable-rate.
- The cost of a mortgage will depend on the type of loan, the term (such as 30 years), and the interest rate the lender charges.
How Mortgages Work ?
Individuals and businesses use mortgages to buy real estate without paying the entire purchase price upfront. Over a specified number of years, the borrower repays the loan, plus interest, until they own the property free and clear. Mortgages are also known as “liens against property” or “claims on property.” If the borrower stops paying the mortgage, the lender can foreclose on the property.
For example, in a residential mortgage, a homebuyer pledges their house to the bank or other lender, which then has a claim on the property should the buyer default on paying the mortgage. In the case of a foreclosure, the lender may evict the home’s residents and sell the property, using the money from the sale to pay off the mortgage debt.
Average Mortgage Rates 2020
How much you’ll have to pay for a mortgage depends on the type of mortgage (such as fixed or adjustable, its term (such as 20 or 30 years), and interest rates at the time. Interest rates can vary from week to week and from lender to lender, so it pays to shop around.
In 2020, mortgage rates were at near-record lows. At year’s end, average interest rates, according to the Federal Home Loan Mortgage Corporation, looked like this:2
- 30-year fixed-rate mortgage: 2.67%
- 15-year fixed-rate mortgage: 2.17%
- 5/1 adjustable-rate mortgage: 2.71%
( A 5/1 adjustable-rate mortgage is an ARM that maintains a fixed interest rate for the first five years, then adjusts each year after that.)
Is it bad to have a mortgage?
Imagine you go to a restaurant. Someone at the table has oysters. You hate oysters. But are oysters bad? Good? Who’s to say? We all have our preferences.
The same is true with mortgages. Some people see debt as something to be avoided at all costs. Others see it as a way to live better or as a tool to (hopefully) increase wealth.
Objectively, what’s bad about debt is the irresponsible use of credit — spending money you don’t have on things you don’t need, spending too much money or having too much debt given your ability to repay.
The fact is, we all need a place to live, but buying a home with cash is simply not possible for many of us. Home prices have risen so much so that it’s taking would-be homeowners years to accumulate enough savings to buy. When you consider this reality and the basic need for shelter, a mortgage can be “good” debt to take on — if you’re able to reasonably afford the payments, and have enough money for a minimum down payment and closing costs.
Mortgage vs. no mortgage
Aside from being an option for those unable to buy a home outright, one major benefit to financing has been the ability to write off mortgage interest.
When you deduct your mortgage interest, your payments don’t decrease month to month, but your income taxes for the year do, lowering your costs overall. (In many cases, your state income taxes would be lower, as well.)
This deduction historically made having a mortgage more attractive for many homeowners. However, with the Tax Cuts and Jobs Act of 2017, the standard deduction increased to the point where it no longer made sense for many taxpayers to itemize their deductions, effectively eliminating the mortgage interest write-off. According to the Urban Institute/Brookings Institution Tax Policy Center, only 4 percent of taxpayers were likely to write off mortgage interest under the new law, down from 21 percent previously.
Buying with cash, on the other hand, has some advantages. You don’t have to qualify with a lender or make any monthly loan payments, including paying for private mortgage insurance.
In addition, you don’t have to pay interest like you would with a mortgage. To compare, if you buy a $275,000 home with a 3 percent, 30-year loan, and make a 3.5 percent down payment, the interest over the life of the loan will add up to $137,589 — money you’re spending in addition to the purchase price of the home. With a cash purchase, you’d spare yourself that cost.
Cash has drawbacks, however. One problem is that your liquidity is limited — when real estate is owned free and clear of all mortgage debt, it can be difficult to extract cash. You can get financing, of course, but that raises all the issues associated with obtaining a mortgage: approval, cost, possibly mortgage insurance, etc.
Owning a home without a mortgage may not be as “free” as it seems, either. The cash you used to purchase the home is now money that can’t be used for possibly better alternatives, such as investing, starting a business or paying for education.
Should I pay off or prepay my mortgage?
If you already have a mortgage, you may find yourself with the means to make extra payments or pay it off entirely. Paying your loan off sooner can be especially appealing if you’re close to retirement and want to lower your monthly expenses.
Most loans today allow prepayments, in whole or in part, without penalty. In other words, if you want to throw an extra $50 or $100 a month toward your mortgage, you can likely do it.
Realistically, though, not many borrowers keep a mortgage for 30 years or anywhere close to that. So, if you make extra payments, the result will be that when sell your home or refinance, you’ll owe less to your lender.
Just like with a cash purchase, if you’re considering paying off your mortgage completely, keep in mind that there may be other, better uses for those funds. Remember that a mortgage can be considered “good” debt if it’s used responsibly, and your life plans may change, so it’s best to consider your goals and priorities carefully before making this decision.