208_The 30 Year Mortgage is Not Your Friend

Adventures in Sustainable Living Podcast

Episode 208

The 30 Year Mortgage is Not Your Friend

In today’s culture, borrowing money and making purchases on credit is a way of life. It is the only way most of us are able to afford the “big ticket” items. In fact, many of us could not fathom how our lives would function if we were not able to utilize the credit system.  We borrow money, make payments with interest, pay off the loan and thus establish a sound financial history. This then becomes the basis for borrowing more money in the future.

But what if this was not necessary? What if there was a different way? Have we become so deluded with our modern way of life that we are now trapped? So join me for E208 Why the 30 Year Mortgage is Not Your Friend.

Welcome back everyone to the Adventures in Sustainable Living Podcast. This is your host Patrick and this is E208 Why the 30 Year Mortgage is Not Your Friend

Essentially what I want to focus on in this episode is to discuss one of the major trappings of modern culture, that being the 30 year mortgage. But I want to also give you a short history lesson on the mortgage as well as how and why it came to be what it is today. Then I will give you a real life example of why a long-term mortgage is not your friend. And in the end I will give you several alternatives to avoiding that financial trap. 

But before we get started with that I want to remind you that the sustainability tip of the week will be given at the end of this episode. So stick around until the end. Before we get started though let’s talk about the good news story of the week.

This weeks story is really more of an example of the power of nature to regenerate even after a massive destructive event. It also points out how so many things in nature in interdependent.

When Mount St. Helens erupted in 1980 life for miles around the volcano was literally incinerated. Two years after the eruption some scientist had a theory that gophers may be able to help regenerate plant life by digging up beneficial bacteria and fungi. As an experiment they dropped gophers on various parts of the mountain for only 24 hours. The results of this were quite astonishing. A few years after the eruption there were only a few dozen plants that had established themselves, likely due to birds dropping seeds. But 6 years after the experiment there were 40,000 plants on the plots where gophers had been dropped. All the remaining land remained mostly barren. The gophers digging up old soil that contained vital nutrients, bacteria and fungi, and moving that to the surface had an astonishing effect.

Additionally, on one side of the mountain was a old growth forest. When the needles on the trees were scorched and fell to the ground, those needles also contained vital bacteria and fungi. In some area, regrowth began almost immediately. In contrast, on the other side of the mountain there were an area that had been clear cut by logging. That area continued to be almost entirely devoid of plant life.

What this demonstrates is just how vital microbes, fungi and pathogens in the soil are for regenerating life after a natural disaster. The results of this experiment also underscores how much there is to learn about rescuing distressed ecosystems. Who would have ever thought that the gophers that are so often seen as pests could produce environmental benefits that have continued for decades. So, in the end we can never underestimate the power of the little guy.

So, that being said, lets move on to this weeks episode.

If you have been listening to me long enough you know very well that I am strongly in favor of keeping life as simple as possible. And I think the concepts and very foundations of a sustainable life go right along with how I think and how I want to live. After all sustainability in many ways is about living on less, conserving resources, living more in tune with nature, having a healthier lifestyle, and in some ways even avoiding the trappings of our modern culture.

That being said, if you have listened to a number of my podcast episodes you also know that there was a time when my life was anything but simple. Just like the average person, I wanted more, bought more, borrowed money, and paid the price by having a life where I lived only to work even more. At one point I had two mortgages, student loans, credit card debt, and car payments all of which amounted to being neck deep in debt. 

Then I got to the point where I asked myself why I was doing what I was doing. After all I was truly seeking simplicity so how did this happen. Once I realized the error of my ways and started having doubts about the lifestyle I had worked so hard to create, I decided to change everything. It took me about 5 years to get myself completely out of debt. Since that time I have made a couple of large purchases but since I had no other debt I was able to take out a loan and pay it off in less than 18 months.

Now there are many things in our modern culture that tend to trap us in a certain way of life because initially it all appears very attractive. However, nothing does that more effectively than the 30 year mortgage. What I want to accomplish in this episode is to give you a slightly different perspective on how you can have the things you want, limit your debt to a great degree, still have a tremendous amount of personal freedom, and have a life that is easier on the environment and much more sustainable.

For now the only thing I want to focus on is how we get trapped into modern society by the 30 year mortgage. Yet this is only one way in which the financial system in our culture truly traps us because we are convinced to buy now pay later. But I also want to give you a real life example of how the 30 year mortgage is truly not your friend. 

Historian Daniel Boorstin once said that “…it was hardly an exaggeration to say that the American standard of living was bought on the installment plan.” That said, using the installment plan helps us to establish a sound credit history which of course serves us well down the road when we want to purchase other more expensive items especially real estate. Securing a mortgage loan thus make it feasible for the common person to purchase a home or land so that we may “have our own place”.

Such practices are now so common place in our culture that we take it for granted. After all, it is these types of financial practices, the ability to buy now and pay later, that make so many things available to us and in many ways actually enhances our quality of life.  However, I truly question whether or not such practices are in our best interest? Furthermore, is the 30 year mortgage the only way to have your own home?

Many people would argue that having a mortgage is the only way they will ever own land or a house. I completely understand that argument because I have borrowed money on several occasions for the same reason. But during the process of doing that, I also learned a few valuable lessons that I want to pass on just to give you a different perspective. But before we get to that I think it is valuable to emphasize something by giving you a very short history lesson on the mortgage market.

A History Lesson on the Mortgage Market

The practice of having a mortgage to purchase property extends far back in human history, as early as 1190, and it seems to have started in England. As Europeans began to settle the Americas, they brought many of their practices with them. As land and property ownership increased so did the need for mortgages. At least in the United States, by the early 1900s, mortgages were widespread and readily available. However, at the time, not everyone could obtain a mortgage.

For those seeking to purchase property, they often had to put up a 50% down payment and the term of the mortgage was 5 years. This practice continued until the Great Depression when there were thousands of foreclosures and the financial system collapsed.

Then the federal government stepped in with Franklin D Roosevelt’s New Deal which brought sweeping changes to the banking and securities industry and forever changed the structure of the mortgage. These changes gave birth to the Federal Housing Administration (FHA), the Federal National Mortgage Association (Fanny Mae), and promoted fair lending practices. Afterwards mortgage-lending funds became easily available.

After World War II veterans began returning home and entering the work force. The demand for mortgages increased and the Veterans Administration was given authority to guarantee loans issued by private lenders. This created a massive economic boom. Furthermore, when baby boomers started entering the work force, double income families became common place. They wanted larger homes and the demand for mortgages increased again.  By the 1950s and 60s most mortgages were 20 to 30 years.

In the 1970s interest rates rose significantly. Consequently, the mortgage market had to adapt and mortgage terms were shortened significantly. By the 1980s interest rates rose to more than 21%. But by 1998, interest rates had dropped to about 6.5% to about 7.0% and there was about $381 billion in outstanding mortgages. Then along came the financial crisis of 2008 in which housing values fell dramatically. Foreclosures skyrocketed and many people lost their investments, life savings, and even retirement funds. And by the way, those that were truly responsible for that financial crisis were protected by the federal government and they got to keep all of their money while so many others lost everything.

The Ever Changing Mortgage Market 

One of the most important financial decisions that you will make is whether or not to purchase you own home. Since only a small percentage of people can afford to pay cash for such a purchase, most people are required to take on a mortgage. Despite the fact that the mortgage market has been fraught with booms and busts, which have both enriched and impoverished many people, the mortgage still remains as the principle means of purchasing property.

As you can see from the history lesson above, there are many factors that affect the mortgage market. Many of these things are completely unpredictable and out of your control. The mortgage market changes on a regular basis and is constantly adapting in order to extend home ownership to as many families and individuals as possible. There are hundreds, if not thousands, of programs available that make it possible for people in nearly every economic situation to own a home. You just have to find the right program and choose wisely.

Consider the True Cost of a Mortgage

When you consider signing up for a mortgage, you have to take into consideration what that loan is really going to cost you. A perfect example is what most of us experience when we try to purchase a new vehicle. The sales person often attempts to tailor the payments to your budget and diverts your attention away from the “true cost” of the loan. Consequently, we tend to focus more on having an affordable payment. To some degree, we put on the same sort of blinders when signing up for a mortgage. All we tend to focus on is a payment that we can afford and the fact that we will finally be in a place of our own.

However, the more prudent approach would be to take a long hard look at what that loan is really going to cost you over time. What most people do not realize, and this was a valuable lesson for me, is that once the interest on the loan is amortized, you are continually charged interest on the initial loan value, not the remaining principle. Therefore, as you pay down the principle on the loan each month the amount of interest that you are charged does not go down. Additionally, this does not include the loan origination fees and other up-front costs of applying for the loan. All of this truly adds up to a very subtle financial trap that so many of us get sucked into including myself.

All of that being said, allow me to give you a real life example of how the 30 year mortgage can work against you. And again this is something I learned only from personal experience.

A Real Life Example

The last time I mortgaged a home was on a place in South Carolina.  All of my family is still in the southern United States and what I wanted was a modest home where I could live and work for part of the year and spend time with family.

That mortgage was the typical setup where my monthly payment included allotments for principle, interest, mortgage insurance, and escrow for property taxes. My monthly payment was about $1,085, which means I was out of pocket $13,020 per year. Out of that, about  $2900 per year went toward principle, $1,100 per year for property taxes, $1,650 per year for insurance, and about $7,400 per year for interest.

Since I was able to deduct property taxes and mortgage interest on my income tax return, that at least saved me some money by reducing my taxable income. This deduction totaled $8500 per year which means I saved roughly $2500 per year in income tax. Over a 5 year period that comes to a savings of $12,500 in taxes.

At first glance, that appears to be a good deal. However, look at what I had to do to get that kind of savings. Just talking in round figures, over 5 years I am out of pocket about $65,000. During that time, my principle on the loan is being reduced by $14,500 and I am saving $12,500 in taxes. Therefore, the total benefit for me over 5 years is $27,000. That means over 5 years I am out of pocket $38,000 for something that produces zero benefit for me. And this means over the life of the mortgage I will be out of pocket $228,000 dollars for something that produces no benefit to me. Yet in many developed countries this is standard market practice and thus is it the price you pay just for the privilege of borrowing money from the bank.

What is the Answer?

First of all I have to say that such practice are what I would consider robbery. You purchase a property for $100K and over 30 years you pay $300K. So unless the market value increases by at least 5 times then it really cannot be considered a worthy investment. Yet this is standard practice.

So, that begs the question of what is the answer?

I am not saying that mortgages are a bad thing. It does enable us to buy property that we otherwise would not be able to afford. Most of us cannot come up with the incredible amount of money that would be needed in order to completely avoid a mortgage. But, what we can do is be sensible about how we purchase real estate. Many of us are so compelled to purchase a place of our own that we go out on a limb financially and end up paying a big price tag for that decision. But, there is a better way to go about doing this.

The best thing you can do is take your time and purchase carefully. Live well within your means and save money on a regular basis. Budget yourself over a period of several years and save up a substantial down payment. Keep an above average credit score which will make the loan process go smoother. Prequalify for a loan then purchase property that is well within your means. Start small and build from there. Make sure you purchase a property you are willing to live with for a period of time in case the housing market takes a dive and real estate prices decline dramatically.

While all of this makes sense, that is not what most people do. There are many programs on the market that allow people to put up a very minimal down payment and qualify to purchase a home even if their financial position is somewhat marginal. But again,  there is a much different way to do this.

Some very good friends of mine bought their first place many years ago. It was a very small condominium. They lived in that place for years, sold it and purchased something bigger. Each time they bought and sold they upgraded. Consequently, they now live in a home that is worth over $2 million.

Some other friends of mine lived for many years in a tiny little cabin. Nate was a diesel mechanic and Dawn worked in the bakery department in a local supermarket. They consistently saved money and eventually paid cash for their first home. Both of these friends now live in nice homes and are prime examples of forethought and planning. Unlike what I did when I purchased the cabin property.

When I bought my cabin property, I did so without a lot of forethought and planning. All I could see was that I had the opportunity to purchase a piece of land that was exactly what I’d wanted. But I had to borrow money.  In the end, things worked out fine. But, life was really tough for several years.

Since I had previous construction experience, I was able to build the cabin without borrowing any money to cover the costs. For various larger projects that I was unable to do myself, especially excavation work, I saved the money and paid someone cash. Furthermore, the cabin is completely off the grid so I do not pay monthly utility bills.

But another thing I did after taking out the original mortgage is that over the first two years I worked a lot of extra hours and paid down the balance by 35%. At that point interest rates were lower so I refinanced. In fact I refinanced twice during the course of the loan and it saved me a considerable amount of money. By getting creative I managed to pay off the mortgage on the land in 12 years instead of thirty. Any improvements were paid for in cash. The point being is that there are ways to have you own place and not be in debt for 30 years.

Since I have lived and worked outside the United States a fair amount, I have seen relatively poor people manage to have their own homes by doing a variety of things. In many countries having a mortgage is not an option. So what people do is similar to what I did at the cabin. They purchase some land first. Then they pay cash to build a small home. They live with that for a few years and then they put an addition. Often times there are several family members that are involved in this whole process because the point is to have a home for the entire family.  The end result is that over time they end up with a very nice home, never have a mortgage, and the property stays in the family for many years.

Another thing I recently discovered is that some countries offer mortgages that are much more consumer friendly. For example, some banks offer what is called a “True Reducing Balance” mortgage. What this means is that as you are repaying the loan, the balance owed is reducing and the interest you pay is also reducing. So the interest you pay is calculated on the balance due which will save you a considerable amount of money during the life of the loan. This is similar to what happens with most automobile loans.

As stated earlier, in the United States, once mortgage loan interest is amortized, it never changes regardless of the principle balance that is due. With that type of loan it makes no difference if you pay extra toward the principle. You are still going to pay the same amount of interest. Consequently, if you purchased a home for $300,000, once you get the balance down to $50,000 you are still paying interest on the original loan amount. This of course is very beneficial to the bank but it pillages the consumer just for the privilege of borrowing money.

Another way in which consumers are taken advantage of is this concept of loan origination fees. These fees are designed to cover the lenders overhead costs such as reviewing and verifying loan applications, ordering appraisals, property inspections, obtaining credit reports, loan officer time and expertise, etc. First of all, considering the significant amount of profit a lender makes on a mortgage, you would think these fees and costs would be covered. However, in some cases, I have seen loan originations fees of almost $20,000 which is insane. How can it possibly cost $20K to review paperwork, order appraisals, do property inspections, etc.

With forethought and planning, and perhaps a lot of hard work, you can save yourself a substantial amount of money. You just have to be creative and think outside the box. Don’t allow our engrained financial system to establish stringent boundaries and dictate how you have to function. Don’t get in debt over your head and lose the freedom to live life on your own terms. There are so many different ways of doing things other than being constrained by mainstream.

My cabin is very simple. It has all that I need to be comfortable, warm, and safe. And it is paid off. Many of my friends live in much larger, much nicer homes, and drive brand new cars. They also routinely ask me how I can afford to take off for a month at a time and travel. It is because I keep my life simple.

I distinctly remember the look on the banker’s face the day I walked in to give them a substantial amount of money in order to pay off my mortgage. This person had a blank stare on their face said, “But no one does that.”

Admittedly I do have the tendency to look at how things used to be when I was growing up in Tennessee and Georgia. Things at the time seemed simpler and easier and were certainly much less expensive. For example, in 1965 the average price of a home was around $22K and the average mortgage payment was $92/month. Presently the average mortgage payment in Colorado is between $2500 and $3000 per month and houses are $600,000 and up. It is truly hard to believe.

One of the things I talk about most frequently is keeping your life as simple as possible. But many of us are so conditioned to conform to the norms of our society that we miss the opportunity to do something in a completely different way. We bury ourselves in debt because we think that is the only way to have what we want and we pay the price by willingly giving up our personal freedom.

So many people continue to ask me how I do what I do. Yet the answer is really very simple. I am not afraid to live outside of mainstream. I am not afraid to challenge the norms of society and do things completely differently. It may have very well taken me longer to accomplish what I wanted. But at the end of the day I am debt free and have far more personal freedom than anyone else that I know.

Living sustainably in many ways means living simply. Yet if you decided to start living a more sustainable life, that is not going to happen over night. It will be a process, one step at a time, one small improvement at a time. You are not going to dive in head first and wake up tomorrow having a perfectly sustainable life.

But you can apply some of these same principles to purchasing a home if you are willing to think outside the box. After all purchasing a home is one of the biggest financial decisions that any of us will make during our lifetimes. We shouldn’t allow that to be a financial trap.

Sustainability tip of the week.

This week’s sustainability tip has to do with food waste. The amount of food that we waste is the single largest component that takes up space in our landfills. Nearly 40% of the food produced is wasted by one means or another. Household food waste is a primary contributor to that bottom line. The amount of food we waste is enough to feed 2 billion people every year and yet people around the world continue to go hungry. We clearly have room for improvement. Of all the things we do, it is possible to reduce your food waste to zero. Make that your sustainability goal over the next year. Then share what you have learned with at least two other people. This is by far one of the most environmentally friendly things we can do.

When I purchase the house in South Carolina I still had a mortgage on the cabin property in Colorado. I went to the bank, filled out paperwork to prequalify for a loan. Based on my financial history the bank was willing to loan me a considerable amount of money. I then found a real estate agent and shared with him how much money the bank was willing to loan me. Then I told him to subtract 40% from that amount and that would be the price range where I would shop for a home. Consequently, I ended up with a nice home and a mortgage that was well within my budget. It was easy for me to put money into the home for improvements.

When I decided to sell the home it was on the market for less than 6 weeks. All because I did things a little differently. So the next time you go to sign on the dotted line for some expensive purchase, take a moment to ask yourself if you are about to limit your personal freedom and limit your options for how you truly want to live your life. If you avoid such temptations, you will keep things simple, live more sustainably, end up with much more personal freedom and a quality of life far greater than the average person.