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Here’s why Warren Buffett thinks using a mortgage is a smart move

By on October 13, 2022 0

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Mortgage rates have skyrocketed in 2022. The average interest rate on a 30-year fixed rate mortgage was just over 3% at the start of the year, but has more than doubled to 6.7% at the beginning of October.

You might think that because mortgage rates have risen so much and house prices have risen sharply since the start of the pandemic, home ownership has become less affordable, and you would be right. In fact, the average new mortgage payment is approximately 70% higher than early 2021. However, if you have home ownership ambitions, it’s worth mentioning why one of the smartest financial minds in the world is usually a mortgage geek.

A one-sided renegotiation

Warren Buffett has generally been a major critic of consumer debt, but mortgages are an exception. One of Buffett’s favorite things about mortgages (especially 30-year fixed rate mortgages) is that they can be refinanced.

As Buffett said in reference to someone who thought the then-current mortgage rate was attractive, “Because if you’re wrong and rates hit 2%, which I don’t think they will, you pay it back (refinance) It’s a one way renegotiation It’s an incredibly attractive instrument for the owner and you have a one way bet.

In other words, if you get a mortgage with a fixed interest rate of, say, 6.75% right now, that’s the highest your borrowing costs will be for the next three decades. But if at any time over the next 30 years, mortgage rates drop dramatically, you can simply apply for a new loan regardless of the prevailing interest rate. On the other hand, no matter how high mortgage rates are, your rate can never go up.

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It is important to realize that mortgage rates fluctuate considerably over time. Over the past 30 years, the average 30-year fixed-rate mortgage interest rate has varied from about 2.65% in early 2021 to over 9% in the mid-1990s. ‘a crystal ball that can predict future interest rates, history shows that there’s a good chance you can refinance at a lower rate at some point if you buy a house today.

Additionally, a mortgage is one of the only major types of low-interest debt that is backed by an asset that is likely to increase in value over time. You can certainly refinance a car loan if rates go down, but the value of your car declines quite quickly in the first few years you own it.

Finally, according to Buffett, even if you can afford to pay cash for a home, using a mortgage can make good financial sense. If you can reasonably expect to get better results by investing the money you’re not paying in interest on the mortgage, it may be advantageous to keep this capital free.

In fact, despite already being very wealthy, Buffett himself used a 30-year mortgage in 1971 to finance the purchase of a $150,000 vacation home because he thought he could do better with life. money than the interest he was paying for the house. (Note: Mortgage rates were between 7.3% and 7.7% in 1971).

A good form of debt, if that makes sense to you

Getting a mortgage isn’t fair or convenient for everyone. This usually makes sense for people planning to stay in their home for a long time (at least 5-7 years), and while there’s a good chance you could eventually refinance and lower your payments, it’s important to make sure you can comfortably pay your monthly payments now.

However, the bottom line is that if you can afford the payments, today’s high mortgage rates shouldn’t necessarily deter you from home ownership. After all, the cost of rent has also risen dramatically in recent years, and if rates drop, you can simply get another mortgage to replace it. And while house prices don’t move in a straight line, your home will likely be worth a lot more in a decade or two.

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