How To Make Your Mortgage Work For You

As you can see, we are back on a financial footing here.From here onwards, it is likelywe will switch back and forth between human interest and personal finance topics each month.For this month’s column, we will take a look at how you can turn a monthly burden; a financial ball and chain, into an account-expanding experience as well as a means of acquiring additional property and paying them quickly.

First, we have to outline some assumptions to set as boundaries.There are a number of ‘rules of thumb’ that should be followed with regards to purchasing a house.We will focus on two of them.First, you should not spend more than 1/3 of your gross income on your home.This includes interest costs, repayments, ancillary costs (that is, non-essential spending on the home), upkeep and repairs.

Then there is the 6% rule which says that the maintenance of a house and a mortgage covering 80% of the purchase price of the home should amount to around 6% of the purchase price of the home.

Assuming that you are staying within the bounds of these two rules, we can proceed.Just do note that most people who are not fans of this sort of spending are usually living beyond their means.They often choose to spend more than 33% of their income on housing costs, or worse, spend that much on car payments (that’s another column entirely).Such attitudes towards spending usually manifest themselves in other ways as well: hefty credit card debt and low savings rates are other red flags.

But I digress. Let’s assume that you, Tom Roberts, are the proud owner of a 3-bedroom house in Happyfluffytown, Idaho. You purchased it for $100,000 and contributed a $20,000 down payment out of your own pocket (which was 12 years worth of Starbucks coffee.)Thus you took out a 30-year, $80,000 mortgage which you locked in at 5% for 5 years.That would saddle you with a $429.46 payment each month.

Now, since 1968, housing prices have risen an average of 6.34% a year in the US.That means that unless you build on Three Mile Island or another oasis of toxicity, you should be looking at a return of at least 6% on your money.

But wait, there’s more: add up the parts here to get a better picture of the whole:

Your house appreciates at roughly 6.34% a year.

You have an $80,000 mortgage on a $100,000 house that will be refinanced in 5 years.

You are paying only $429.46USD a month in mortgage costs (and with an average wage of $36,764 in the USA, you are likely well under the ‘1/3’ rule.)

When you refinance, you will be granted a mortgage based on ~80% of the value of your home.But let’s look a little closer.In the past five years, your house has appreciated to $135,982.58 ($100,000 x 5 years x 6.34% per year) and as you can mortgage your house for 80% of its value, you now have a possible $108,786.06 mortgage.

The simple beauty of the next move is now readily apparent.You pay off the first mortgage with the second, take the difference, and put a down payment on another house.

You have paid down your first mortgage from $80,000 to $73,463 through five years of monthly payments.The new mortgage of $108,786.06 pays off the remainder of the first mortgage, leaving you $35,323.06 with which to buy another $100,000 house.We will assume that you refinance at 6%, locked in for 5 years.Your monthly payments are now $652 on your existing house and $387 on your new property (with a mortgage of $64,676.94 - also locked in for 5 years at 6%.)But assuming you can rent out your new home for at least $700-800 each month (not unreasonable for a three bedroom home in Boise), you are coming out well ahead, letting someone else pay the mortgage completely on your new home and helping you out with the mortgage on your first home.

Assuming the market stays as it has for the few decades, this should be a viable plan.There IS the possibility of a market crash; there IS the possibility of another 1930’s-like Great Depression before your plans come to maturity.But all things being equal, this strategy would allow you to build a portfolio of 5-6 properties in 30 years, a nice little nest egg to say the least.