The Downside of Taking Out a Mortgage. - Tax Professionals Member Article By KLSM CPA Firm PLLC
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The Downside of Taking Out a Mortgage.

The Downside of Taking Out a Mortgage.

Purchasing a home is often the most important financial decision of our lives, and for most of us, that means getting a mortgage. Mortgages can mean long-term borrowing at a relatively low cost, but finding the right deal for you is essential with sums this large. Our guide will focus solely on the downsides of a mortgage to help you decide.


Should I take out a mortgage?

If you want to buy a house, unless you can pay cash, you will need to take out a loan, which usually means a mortgage. But before deciding whether or not to get a mortgage, there are a few considerations.


How much home can I afford?

The size of property you can afford depends on how much down payment you can make and how much you can borrow from a mortgage lender. Each lender will have specific criteria, like lending four and a half times your salary.

However, the amount you can borrow also depends on other factors, such as your credit score, income, and regular expenses. If you can't borrow as much as you want, you may need to foreclose on your mortgage or find a cheaper property.


How much do I need to put down upfront?

The amount of your cash deposit to buy your property determines the amount of mortgage you will need. The larger the initial deposit, the less you will need to borrow and the less interest you will have to pay overall.

A larger deposit also means you own more assets, called equity, which usually means you can get a better mortgage (with lower interest rates).


What type of mortgage should I get?

The mortgage you choose depends on your personal preferences and attitude towards risk. Fixed-rate mortgages are popular with homebuyers who want the security of knowing what their expenses will be each month, although you may pay a little extra for peace of mind.

Borrowers who think interest rates might drop may prefer a low variable rate mortgage or a follow-on mortgage. You also have options regarding the term of the loan. The term of a standard mortgage is 25 years but can often be extended to 30 years or even longer, depending on age and the lender's policy. In the longer term, your monthly payments will be lower, but you will generally pay more interest.


What if I want to pay the mortgage in advance?

It's worth thinking about what will happen if you think you can pay off your mortgage sooner, as most mortgages have a prepayment charge that comes into play if you want to pay off the loan during the introductory period.

Initial offers usually last for two, three, or five years, so think about how your financial situation changes. Do you probably want to move, for example, or do you want to pay off part of your loan?


What if I can't pay the mortgage?

Lenders will perform strict affordability checks to ensure you can afford a new mortgage's monthly payments. But you should be happy with the numbers and able to repay the loan.

If you think you might be struggling, consider waiting until your financial situation improves before committing to a mortgage, or consider borrowing less by moving to a cheaper property.


Downsides to taking a mortgage

Being in debt: Many people strive to be debt free. A mortgage is a big debt, which can make some borrowers uncomfortable.

Interest payments: Part of your money goes towards interest when you pay a mortgage. Some may see this as wasted money because they won't be paying the mortgage itself.

Rate Fluctuation Risk: If you don't have a fixed rate mortgage, you risk the interest rate on your mortgage increasing over time.

There may be additional costs: It's not just the interest rate you need to think about on a mortgage; also, you need to consider mortgage expenses such as settlement fees, appraisal fees, remortgage fees (if you remortgage), and moving costs. If you want to prepay your mortgage, you may need to pay prepayment charges.


Your home is at risk if you can't meet your payments: Because the value of your property secures a mortgage, if your circumstances change and you cannot make payments, your home can be repossessed to pay off your debt. If your financial status changes and you have difficulty making payments, speak to your lender immediately. They may help you by allowing you to withhold payments for a period to take a break or even restructure the company to make it more accessible.

 

Making the right decision on Mortgage vs. No mortgage

As well as being an option for those unable to purchase a home outright, one of the main benefits of the mortgage is the ability to pay mortgage interest.

When you subtract your mortgage interest, your payments will not decrease month to month, but your monthly income taxes go down, lowering your overall costs. (In many cases, your state income tax would also be lower.)

Historically, this deduction has made mortgages more attractive to many homeowners. However, with the TCJA (Tax Cuts and Jobs Act) 2017, the standard deduction has increased to the point where it no longer makes sense for many taxpayers to itemize their deductions, eliminating the minimum mortgage interest requirement.

On the other hand, buying with cash has its advantages. No need to qualify with a lender or make monthly payments on the mortgage, including private mortgage insurance payments.

You also don't have to pay interest like you would on a mortgage. For comparison, if you bought a $320,000 home with a 30-year loan at 5.81% and made a 3% down payment, the interest over the loan would be $346,131 money you spend in addition to purchasing housing costs. With a cash purchase, you will save on this cost.

However, cash has its drawbacks. One problem is that their liquidity is limited: when properties are freehold and free of mortgage debt, it can be challenging to extract cash. You can get financing, but that raises all the questions about getting a mortgage: approval, cost, possibly mortgage insurance, etc.

Homeownership without a mortgage may not be as "free" as it seems. You bought the house with money that cannot be used for better alternatives, such as investing, starting a business, or paying for education.

Ultimately, the decision comes down to whether there is something better out there that could make you money. Can you continue to make the monthly payment and invest the remaining money in investment vehicles that will help you grow? If so, you might want to stick to your payment schedule. Putting down a down payment can be helpful if you prioritize peace of mind and want to buy your home.


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