This guest commentary was written by Ed Harris, CEO of Harris Northwest Advisors and a Visiting Contributor at the Southwest Public Policy Institute.
In his argument about APR, Patrick Brenner is wrong but inadvertently correct on a larger point he doesn’t address.
An APR calculation is mathematically accurate. Most fixed-rate 30-year mortgages are priced similarly, driven by both market forces and a desire to conform to FHA guidelines and thus be easily packaged into asset-backed securities. So a fixed-rate mortgage at current levels of around 6% is likely to have an APR pretty close to that. Not misleading, as contended, rather crystal-clear.
If only there were similar transparency in car rentals or cell phone bills. Anyone who travels knows that when you book a car rental for, say, $79 per day, upon your return four days later, the bill is over $700 due to a smorgasbord of fees. Same with that $50 monthly cell phone plan that ends up costing over $100.
Mr. Brenner’s contention that a mortgage is much more expensive than the APR suggests is based on adding up payments over the life of the loan. This argument is flawed because the most fundamental rule of finance is that cash in the future is worth less than cash today. Since the end of World War II, inflation in the United States has averaged 3.7% per year. By year 30, every future dollar of mortgage payment will be worth 33 cents in today’s money, if historical inflation trends continue.
That’s why you might have heard your grandparents say that everything used to be so much cheaper. It was, in nominal dollars. They forget that in 1960, the median household income in the United States was $5,600. Being a millionaire in the old days really meant something.
Another advantage of borrowing money is that the interest expense is tax-deductible. So a pre-tax rate of 6% might be an after-tax cost of only 4%.
Finally, another factor associated with borrowing is alternative uses of cash. Since 1982, the average annualized return on the S&P 500 has been 12.2%. Borrowing a large portion of the purchase price frees up cash for other uses. And if you don’t buy a home, you need to rent. For most people, the opportunity to build home equity over a long period of time is a cornerstone of middle-class financial stability.
So Mr. Brenner is flat-out wrong about APR. But he’s onto something with how owning a home is more expensive than you might think.
The reason is insurance, utilities, local taxes, and repairs and maintenance, all of which, unlike a fixed-rate mortgage, are subject to inflation.
I paid $225,00 for my first house, in the lovely but expensive town of Montclair, New Jersey. I checked it out online recently and see that property taxes alone are up to $19,000. Had I stayed there, I would have already paid more than double the tax bill.
Where I currently live, in a Seattle suburb, my out-of-pocket expenses are over $20,000 a year. I’ve noticed over the past couple of summers that many of my neighbors have had new roofs installed. All the houses were built around the same time. My $600 annual roof and gutter cleaning service has allowed me to kick that can down the road, but I know I am within a few years of a $30,000-$40,000 outlay. Painting the exterior a few years ago was around $7,000. That has a finite life, so next time it might be $10,000. My home’s appliances and mechanical fixtures also won’t last forever, and combined, they’ve set me back around $10,000 to replace or repair. The deck in my small backyard cost me $17,000, and so on.
The 30-year mortgage is great, and the APR accurately describes its price. But actually living in your house for 30 years? Wow, just like kids, that’s way more expensive than you could have ever imagined.
