Dueling Mortgage Gurus and Uncertainty

uncertaintyOne of the things that makes finance endlessly fascinating (to me!) is that perfectly sound logic for one situation turns out to be perfect madness in another situation.

In my best moments I appreciate the ironies and contradictions. In my worst moments I despair for people whipsawed by the seeming complexities of financial choices.

Most middle-class folks grapple with one of these important choices – a home mortgage – at least once in their life. I’m a big fan of the choice to buy a home with a mortgage but even there, a controversial battle rages.

Anti-debt

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Dave Ramsey

On one side of the ring stand the anti-debt gurus like Dave Ramsey. While Ramsey really wants his followers to pay cash for their homes (which is fairly absurd), he has strong rules about what to do if you decide to borrow. For example, Ramsey says

  1. Always make at least a 20% down payment, to avoid high interest charges and expensive private mortgage insurance.
  2. Always get a 15-year mortgage rather than a 30-year mortgage because you will pay it off sooner, typically enjoy a lower interest rate, and you’ll pay significantly less interest over the life of the loan.
  3. Never take on mortgage debt with a monthly payment that will command more than 25% of your take-home pay.
  4. Always avoid adjustable rate mortgages which shift the risk of higher interest rates from the lender to you.
  5. Never borrow additional home equity in the form of a home equity loan or line of credit.1

Ramsey – who built a real estate fortune and then went bankrupt by the age of 30 – preaches a low-debt or (preferably) no-debt financial lifestyle as a curative for people with past debt problems. He knows of what he speaks, and he has a certain strong logic for his points.

On the other hand, personally, I’ve broken each and every one of his rules. So I can’t actually advocate following his advice.

Pro-debt

On the opposite side of the ring, another financial guru Ric Edelman advocates the opposite approach.

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Ric Edelman

Since Edelman’s contrarian position flies in the face of conventional wisdom, I enjoy presenting his points even more.

  1. Only make the bare minimum down payment on your house – thereby freeing up your remaining capital for investing in the market, where you can earn an annual return higher than what you pay on your mortgage debt.
  2. Always get a 30-year mortgage rather than a 15-year mortgage, to take advantage of the tax deduction on mortgage interest.
  3. Never pay off your mortgage early or at all, because mortgages are the best way to borrow extremely cheaply. Again, use the borrowed money to invest profitably in the market.
  4. If the value of your house rises, consider freeing up the equity to invest, through a home equity loan or line, rather then let your net worth stay locked up and unused in the form of your house. That way, Edelman says, if the value of your house drops you’ll at least have withdrawn the money and have use of it for emergencies.
  5. Quickly paying down and eliminating your monthly mortgage payment is not an important goal because, as a homeowner, you’ll always have to pay insurance and real estate taxes anyway. Since you can’t eliminate those obligations, why bother trying to eliminate your mortgage payment?

You get the idea. When Ramsey says “Zig” Edelman says “Zag.”

Edelman presents some compelling math for his arguments. If you accept his assumptions then you could end up wealthier in the long run.

However, Edelman does not account for the psychological difficulty of saving money. Specifically, many of us benefit from the ‘forced savings’ of paying a mortgage, and few will have the discipline to take the extra monthly cash flow as a result of a 30 year mortgage and invest it for the long run, rather than squander it on iced latte frappuccinos.

As a result, I’m pretty sure some portion of people who take Edelman’s advice to heart will end up like the proverbial broke guy having to wear a barrel for pants. It kind of all depends on your specific situation.

My choices

In my own life I’ve had both adjustable rate mortgages and fixed rate mortgages. I’ve borrowed more than the conventional 80% limit. I’ve had 15-year and 30-year loans. I’ve paid extra principal on a biweekly basis, and I’ve also borrowed heavily against my home equity line of credit. I’d like to think I had compelling logic for each decision, or at least a sober mind for understanding what I was doing.

How to decide

I think my point is that the more wholly convinced a guru is, the less certain you should be. The stronger they lean in, the less likely they are to be correct in all circumstances, for all people. Ramsey’s got a great plan, for example, for people who’ve been bankrupt in the past or who have a history of debt problems. Edelman’s approach is closer to my own experience because he’s linking some risk-taking to long-term wealth creation, which I tend to do in my own life. But where you fall on the risk spectrum is a key determinant of their relevancy to your own situation.

Big Ideas vs Little Ideas

Nate Silver’s 2012 book The Signal And The Noise presents the dichotomy of a guru or pundit’s ‘big idea’ vs. ‘small ideas.’ While punditry rewards people who have ‘big ideas’ and ‘hot takes’ on topics, the reality is that certainty and big ideas come at a cost. Predicting the future – one of Nate Silver’s specialties – is a difficult business for people with big ideas. They rarely get it right. Instead, Silver advocates adopting a nimbler approach to observing the world.
When I read gurus like Ramsey and Edelman, I remind myself that their certainty is a sign of the ‘big idea’ thinking that Silver warns against, when we might be served better by smaller ideas, more responsive to changing conditions.

The more certain I am, the less likely I am to be wholly right.

 

A version of this post ran in the San Antonio Express News.

Please see related posts:

Book Review: The Signal And The Noise by Nate Silver

My 15-year mortgage – I am a Golden God

Rent vs. Buy a house

Home Equity Lines of Credit are awesome

The Latte Effect in my own life

 

 

 

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  1. I have strong pro-HELOC views, as I’ve written about in the past.

Greece On The Brink: Notes From The Island

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Editor’s note: The following is from The Banker’s Editor-in-Chief, aka Mom.

Mom spends a month every year on a Greek island, populated by ex-pats. She has watched the island move from the drachma-economy of extremely cheap living, to a much more expensive, but possibly unsustainable, economic model. All sides blame others for this crisis. In the details of her note are some hints at the causes and tensions of the crisis.

Greece is in the midst of a financial panic, likely the last few moments before they officially leave the euro and default. 1

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———–

From Mom, June 28, 2015

Afternoon update – I left the beach and went to the port village hoping to use the ATM to get euros for my return to Athens and then the States. Empty.

Morning update – Two summers ago, at an island luncheon, a Greek central banker remarked that in light of the ongoing crisis, Greeks would have to start paying the taxes they owe. But now, as default looms in a few days, I see little change here. Only about half the restaurants give bills rung up on cash registers; the rest still write them down on paper and presumably do not report them as income.  On my way here, one taxi driver from Athens proudly submitted his bill to me with the tax listed, but he is a notable exception. All encounters with bureaucracy, whether at the bank, the town hall, or the ferry ticket office take enough time to infuriate me and that inefficiency may discourage tax-paying. The Greeks, mostly self-employed entrepreneurial taverna owners that I deal with are delightful, helpful, and fatalistic about a bankruptcy over which they have no control. A few consider themselves and fellow countrymen to blame for overspending and over-borrowing, but others talk about the rape and pillage of Greece by the Germans in WWII as a reason for not paying the current debt. The majority of the island residents voted for the current government, which has said the existing debt terms are unacceptable because of the suffering of so many unemployed Greeks.

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The Brits, Dutch, and Germans who have summer houses here love Greece and the Greeks they know, but they are very annoyed that their high taxes, funneled here through EU projects, have been wasted by poor planning and execution as well as by outright corruption in Greece. Lots of unhappy jokes about the 22 million euros spent on the new island reservoir that leaks and the small amounts for hiking paths that tourists use that are now overgrown and have rotting picnic tables. The Europeans are keeping only a bare minimum of euros in their Greek bank accounts so they won’t lose much if those accounts are converted to a devalued “Drachma.” A German partner of the retired local priest who lives here year round, however, has resisted that euro flight and proudly kept significant savings in the local National Bank of Greece.

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Some historical context on the strong views from Greece

When I first came to the little Greek island – where I spend a month every summer – 30 years ago, the Old Village (high on the mountain) had no electricity, one telephone, no paved roads, but many tavernas with beautiful views and fairly quiet generators. Now, especially since joining the EU, and having years of a huge influx of Northern European cash, we have too many cars and scooters, but tourism has never been truly busy since the conversion to the Euro. When the super-cheap prices of tours using the drachma finished, those tourists moved on to Turkey and Bulgaria. Other Europeans and the few adventurous Americans who can afford the new Euro prices either don’t find Greece “shaped-up” enough or resent the ugly things some Greeks have been saying about them as “pillaging” creditors.

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  1. Either default ‘again,’ or default ‘officially’ for the first time on their sovereign debt, depending on your view of what happened over the past few years of debt restructuring and debt extension.