By Mary Kay Robinson
Is a mortgage loan interest rate an asset? Indirectly yes!
Most people are familiar with standard balance sheets that determine net worth: homes, cars, buildings, equipment, deposit account balances are all on the asset side. These are items that can be bought or sold for cash. The liability side of the balance sheet includes loans and accounts payable, which are debt obligations.
So where does the interest rate itself go on the balance sheet? It doesn’t. However, the interest rate does function to improve your cash flow, which in turn, can affect your monthly financial picture and, therefore, net worth. Think of it this way; it is possible as of the date of this writing, to get a mortgage interest rate on an owner occupied home at a rate of 3.875 percent and pay no points. That’s a terrific interest rate. On a $250,000 mortgage, that means your principal and interest payment would be $1175.60. Taxes and insurance would be added to that amount. Rents for that type of home are very close to what you would pay for a mortgage.
Conversely, if interest rates rise to say 5.5 percent – which is still not a bad rate from a historical perspective, the principal and interest payment would rise to $1,419.47. That’s an increase in your housing payment of almost $250 a month! That increase of $250 monthly in your housing costs would require an increase in monthly income of at least $750 just to qualify for the mortgage. Your lender would be looking for a whopping $9,000 increased annual income to accommodate that higher payment.
Interest rates matter. When we pay less for housing (because we have a great interest rate) that frees up more cash for other purchases and investments.
Let’s look at investment property. For investors, non-owner occupied home loan rates are hovering around 4.25 percent with no points. Investors enjoy tax write offs for the mortgage interest and other expenses. A big bonus with investment property is the depreciation of the asset on your tax returns.
All these write offs combine to reduce your taxable income. (That gets into some fairly complex calculations about the after tax net effect which we won’t do here). Now combine the low interest rate environment with the reduced price of homes since the market peaked ’06, ’07 and early ’08. That’s purchasing power! And when you purchase real estate, you are adding an appreciating asset to your portfolio. People always have to live somewhere – whether they rent or own.
Many people want to pay off their mortgage by cashing out assets from their investment portfolio. That is a terrific goal and simplifying one’s finances is enticing. However, if your stock and bond portfolio is earning anywhere between 5 and 6 percent on the conservative side and 7 percent and up if invested more aggressively, then why cash out those assets to pay off a lower interest rate debt? In effect, the rate of return on your money when you pay off the mortgage is the interest rate of that mortgage. The numbers just don’t add up.
On the investment side, the mortgage is paid down with rents received for the rental property. Any extra cash flow (the net over and above the loan payment and bills) can be applied to the mortgage and in time, equity is built which adds to your net worth. Again, if you have a great rate on your rental property, you typically are creating extra cash flow that you can either use to reduce the debt quicker or save and invest in another investment property.
The low interest rate environment along with the reduction in housing prices since the recession, have combined to give us a terrific real estate purchasing opportunity. If you haven’t purchased your home yet, talk to a lender and find out what is possible. There are all sorts of loan programs that can be tailored to your situation. If you are looking to invest, now is the time – before rates and/or housing prices increase further. Once your interest rate is locked in, the debt side of your cash flow is locked as well as the acquisition cost. The only thing you have to focus on is creating the income from that asset.
Mary Kay Robinson is a residential real estate broker with Windermere Real Estate. She has worked in the real estate industry for more than 20 years and currently serves on the Whatcom County Association of Realtors board of directors.