- Your home can have a big effect your ability to build wealth.
- According to a researcher who studied 10,000 millionaires, there are three mortgage-related traps homeowners can fall into that ruin their chances of getting rich: dragging out a mortgage, keeping the mortgage for tax write-offs, and taking on a home equity line of credit.
- Opting for a home you can easily afford is one of the cardinal rules of building wealth.
It’s a common finding among those who study millionaires. Chris Hogan, author of “Everyday Millionaires: How Ordinary People Built Extraordinary Wealth – and How You Can Too,” studied 10,000 American millionaires (defined as those with net worths of at least $US1 million) for seven months with the Dave Ramsey research team.
According to Hogan, there are three “mortgage-related mistakes that can drive your millionaire aspirations off a cliff.” The millionaires he studied were successful in avoiding these mistakes, and that, along with solid incomes and good saving habits, helped them build wealth.
1. Dragging out a mortgage longer than necessary
“If you want to know why most people don’t become millionaires, look no further than the 30-year mortgage,” Hogan wrote. “People throw away tens – even hundreds – of thousands of dollars on these loans without ever stopping to do the maths.”
While income level and spending patterns also contribute to someone’s ability to become a millionaire, Hogan’s research found the average millionaire paid off their house in 11 years, and 67% of the millionaires he studied live in homes with paid-off mortgages. This puts the millionaire’s home entirely in the asset column of their net worth and wipes their biggest debt off the liability column, he said.
Hogan compared a $US225,000 30-year mortgage with a $US225,000 15-year mortgage, each with a 4% fixed interest rate. He found that, if you can afford the higher monthly payments on a 15-year mortgage, “Going against the flow and choosing a 15-year loan would have saved you more than $US87,000 and would have put you in a paid-for home in half the time.”
2. Keeping your mortgage because of tax advantages
While you can write off your mortgage interest on your tax return, it “will never save you more than it costs you,” Hogan said.
“You should absolutely take advantage of the tax deduction as long as you have a mortgage,” Hogan wrote, “but don’t use that deduction as an excuse to keep the mortgage longer than necessary.”
Hogan gives an example in the book of a $US200,000 mortgage with a 5% interest rate. That’s $US10,000 paid in interest annually, he said, which you can deduct from your taxable income. “If you’re in a 25% tax bracket, that deduction will save you $US2,500 a year in taxes,” he wrote. “In that example, you sent the bank $US10,000, and that enabled you to save $US2,500 off your tax bill.”
He continued: “That’s like asking a cashier to break a $US10 for you, but he only gives you back $US2.50 – and you thank him for it.”
While Hogan’s point stands, it doesn’t consider the new tax laws enacted in late 2017 that changed the federal tax brackets, a 25% tax bracket no longer exists, and increased the standard deduction to $US12,000 for single filers and $US24,000 for married filers. That means under the new tax laws, married homeowners who paid less than $US24,000 in mortgage interest for the year might save more money by choosing to claim the standard deduction, instead of itemizing their taxes and claiming a deduction for mortgage interest.
3. Taking on a home equity line of credit
A home equity line of credit (HELOC) is a revolving loan, like a credit card, backed by the value of a borrower’s home. For a fixed amount of time, the credit line is available to the borrower, who can then renew the line or pay back an outstanding balance when the time period is up.
Hogan is not a proponent of HELOCs. His research found that 63% of millionaires have never taken out a home equity loan or line of credit.
“It’s a second mortgage tied to an easy-access debit card that enables you to chip away at your home’s equity one vacation or kitchen upgrade at a time,” Hogan wrote. “It takes two incredibly stupid ideas – a second mortgage and a credit card – and jams them together into one destructive opportunity to sabotage your financial independence.”