The ideal mortgage amount was $1,000,000 before the Tax Cut & Jobs Act was passed for 2018 and beyond. The reason why $1,000,000 was ideal was because that was the mortgage limit for where you can write off the interest. Today, that maximum mortgage size you can get to be able to write off the interest is $750,000.
Back in 2002, a $1 million mortgage cost around $50,000 to $65,000 a year in interest expense given mortgage rates were 5%-6.5% for a 5/1 ARM or a 30-year fixed. Multiply the annual interest expense by three, and you get $150,000-$195,000, the minimum annual income recommended to take out such a loan.
In 2020, a $1 million mortgage costs around $25,000 to $35,00 a year in interest expense given mortgage rates are now ~2.5% for a 5/1 ARM or ~3.5% for a 30-year fixed after interest rates plummeted to all-time lows due to coronavirus fears.
Multiply the annual interest expense by three again and you get $75,000 to $105,000, a far cry from the $150,000 – $195,000 in income you originally needed to make! As a result, buying real estate looks attractive in 2020+ because affordability has gone way up.
You just need to come up with the 20% downpayment, which is one of the main struggles for first time home buyers today. Note, banks still only lend out 3-4X your income despite a drop in rates.
It is aggressive to think that someone who only makes $75,000 – $105,000 a year in gross salary can “afford” a $1 million mortgage, but it’s also absurd that one can borrow $1 million dollars nowadays for only 2.5% – 3.5% if you check places like Credible, one of the leading online lending marketplaces. Best to be more conservative.
Reasons Why The Ideal Mortgage Is $750,000
1) The law says so. The maximum mortgage where you can write off the interest is $750,000 according to the IRS. In other words, if you have a $2 million dollar mortgage that costs $70,000 a year in mortgage interest, only $30,000 of the mortgage interest can be deducted from your income. Your tax savings is simply $30,000 X tax rate. The IRS also stipulates that you can deduct the interest on a $100,000 Home Equity Line Of Credit if the money is used other than to build, improve or purchase your home. Crazy but true.
2) Maximum government subsidy. The home mortgage interest deduction is one of the largest government subsidies available to all citizens. In an environment when all it seems like the government does is take, take, take, citizens get something tangible and immediate back from the government. The government helps subsidize your lifestyle and lower your taxes. To not take full advantage of such subsidy is a shame, unless you love paying taxes!
3) Keeps you disciplined. For those who live in expensive cities such as San Francisco and NYC, keeping a $750,000 dollar mortgage limit helps keep you from going overboard and buying too much house. Plenty of nice houses now cost over $2 million dollars for example. By keeping your borrowing to $750,000, you are forced to come up with a $1,250,000 down payment before you can buy such house.
You might think going the standard 20% down ($400,000) and borrowing $1.6 million is fine, but it is not ideal. You start justifying what’s an extra $600,000 in debt at that price, losing your financial discipline. I can assure you that everything because more painful the more you borrow: less deductions, higher mortgage payment, and more stress.
This is why investing in completely passive real estate crowdfunding investments has gained so much popularity recently. Now investors can access property all over the country much more efficiently.
4) Asymmetric risk and reward. In America, when you borrow a ton of money from a bank and can’t pay it back one day, you don’t get stoned to death, castrated, or impaled in the heart by a spear. Instead, you hand back the keys to the bank who agreed to take on your home as collateral in case of non payment. If you are lucky to live in a non-recourse state, the bank can’t go after your other assets! If you live in a recourse state, then a short-sale or foreclosure will temporarily slaughter your credit score for 3-7 years. Better your credit score then your private parts right? Meanwhile, if you happen to invest in the right cycle, you can make a massive amount of money when you finally sell or rent the property out without having to give the bank any of the upside! Isn’t America great?
5) You make closer to the ideal income. How much mortgage interest you can fully deduct is based on how much money you make. Make too much, and your mortgage interest deductions get phased out. Make too little, which is under $79,500 based on existing rates, and you will feel the strain of the mortgage payments.
If you or your household make between $200,000-$300,000, you are in the sweet spot to take on a $750,000 dollar mortgage. Be aware if have an adjusted gross income of over ~$166,800, your mortgage interest starts to get phased out. For every $100 of income over $166,800 you lose $3 of itemized deduction X 33.3% up to a maximum loss of 80 percent of your itemized deductions. Lower rates have moved everybody closer to the ideal income!
Mortgage Amounts Differ For Everyone
If you live parts of the country which have wonderful $500,000 homes, then awesome! There is never a need to borrow $750,000. The standard deduction of $12,000 for singles and $24,000 for married couples for 2020 is probably good enough for most.
For those of you who live in expensive coastal cities, then consider $750,000 as the cap on how much you should borrow to purchase your primary residence. Once done, consider taking advantage of investing in lower cost areas of the country through real estate crowdsourcing to diversify your investments. As a San Francisco property owner, I’m actively trying to buy heartland real estate.
Some of you reading this have liquid assets north of $1 million dollars. A $750,000 mortgage is therefore nothing to be afraid of because everything is just accounting. Your goal in this low interest rate environment is to minimize your debt interest expense by refinancing your mortgage and maximizing your government subsidies. Imagine refinancing your mortgage to 3% while making a 3% or greater return on your investments? You’re essentially borrowing money for free and then some!
Don’t be afraid of mortgage debt. Instead, cherish what the government has given us and live a wonderful life knowing you are optimizing your finances.
Wealth Building Recommendations
Refinance your mortgage. Check out Credible, one of the largest mortgage lending marketplaces where lenders compete for your business. You’ll get real quotes from pre-vetted, qualified lenders in under three minutes. Credible is the easiest way to compare rates and lenders all in one place. Take advantage of all-time low rates by refinancing today.
Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns. Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
Updated for 2020 and beyond.