The ideal mortgage amount was $1,000,000 before the Tax Cut & Jobs Act was passed for 2018. Today, the ideal mortgage amount is $750,000, if your income can afford it.
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 ideal mortgage amount is $750,000 because $750,000 is the maximum mortgage you can take to be able to write off the mortgage interest.
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 2023, a $1 million mortgage costs around $40,000 – $62,000 a year in interest expense given mortgage rates are now 4% for an ARM and 6.2% a 30-year fixed. Interest rates plummeted to all-time lows in 2020 due to coronavirus fears. However, interest rates rockets in 2022 after the Fed aggressively hiked rates.
Mortgage rates should decline again as inflation peaked in mid-2022. As a result, I'm still very positive on the housing market long term. If you plan to own a property for more than five years, I would buy. The housing market is softening and more deals will be had through 2024.
Reasons Why The Ideal Mortgage Is $750,000
Here are the reasons why the ideal mortgage amount shouldn't surpass $750,000. You can obviously get a much large mortgage if you wish. It just won't be the ideal mortgage amount.
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 $1.5 million dollar mortgage that costs $70,000 a year in mortgage interest, only ~$35,000 of the mortgage interest can be deducted from your income. Your tax savings is simply $35,000 X your marginal tax rate.
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! Just look at how much government subsidy there is during the COVID-19 pandemic. We've got stimulus checks, enhanced government benefits, PPP loans, and more.
Here's how to calculate the mortgage interest deduction if you have a mortgage amount over the maximum.
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 regular 4-bedroom houses now cost over $2 million dollars in big cities. By keeping your borrowing to $750,000, you are forced to come up with a bigger down payment.
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 $850,000 in debt at that price versus the ideal mortgage amount of $750,000.
I can assure you that everything becomes more painful the more you borrow. You get 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. Investors in real estate crowdfunding can earn income 100% passively in a diversified way.
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. Instead, you hand back the keys to the bank. After all, your bank 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. Further, you don't have to give the bank any of the upside! Isn't America great?
5) You make closer to the ideal income.
In the past, 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, and you will feel the strain of the mortgage payments.
If you or your household make between $250,000-$300,000, you are in the sweet spot to take on a $750,000 dollar mortgage. This is because you shouldn’t spend much more than 3X your annual income on a home after putting 20% down. This is my 30/30/3 rule for home-buying.
In expensive big cities like San Francisco, New York City and elsewhere, you may have to stretch to 5X your annual income. However, if you do, just make sure you have rock-steady employment and a good financial cushion. Buying a home that's 5X your annual income is a function of low mortgage rates and future income growth.
The Ideal Mortgage Amount Differs 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 $12,550 for singles and $25,100 for married couples in 2021 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. You goal should be to diversify your real estate investments and take advantage of long-term trends. 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.
Always Take Advantage Of Low Mortgage Rates
Your goal in this low interest rate environment is to minimize your debt interest expense by refinancing your mortgage. You should also maximize your government subsidies with the ideal mortgage amount.
Imagine refinancing your mortgage to 2.5% while making a 2.5% or greater return on your investments? You're essentially borrowing money for free and then some!
Don't be afraid of mortgage debt. Mortgage debt is one of the best types of debt there is. So long as you can take out the ideal mortgage amount that is right for you, you should do well.
The ideal mortgage amount may change with Joe Biden as president. Perhaps he will do away with the SALT cap deduction limit and raise the maximum mortgage indebtedness amount for deductions. However, we'll just have to wait and see.
Wealth Building Recommendations
1) Shop around for lower mortgage rates
Check out the latest mortgage rates online. You'll get real quotes from pre-vetted, qualified lenders in under three minutes. The more free mortgage rate quotes you can get, the more you can compare and make lenders compete for your business.
2) Invest In Real Estate Online
Real estate is my favorite asset class to build wealth. Take a look at Fundrise, one of the largest real estate crowdsourcing companies today. The platform has over 400,000 investors and runs over $3.5 billion. All you need is $10 to get started.
Real estate is a key component of a diversified portfolio. Fundrise offers diversified funds for investors who want exposure to real estate, mainly in the form of single-family home rentals.
The other real estate investing platform to check out is CrowdStreet. CrowdStreet is a real estate investment marketplace that focuses on individual real estate opportunities in 18-hour cities. 18-hour cities have faster growth and lower valuations.
If you are an accredited investor who likes to build their own portfolio, consider Crowdstreet. However, it's up to you to due extra due diligence on the sponsor before investing in any deal. Understand the sponsor's track record and know their management.
For most people, investing in a diversified fund like the ones offered by Fundrise is the way to go. I've invested $810,000 in real estate crowdfunding so far to diversify my expensive SF real estate holdings. I love being able to earn more passive income so I can spend time taking care of my family.
3) Read the best personal finance book
Pick up a copy of Buy This, Not That, my instant Wall Street Journal bestseller. The book helps you make more optimal investment decisions so you can live a better, more fulfilling life.
4) Subscribe to Financial Samurai
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The Ideal Mortgage Amount is an FS original post. In an inflationary environment, you want to be long real estate. Inflation eats away at the cost of your fixed-rate mortgage while boosting the value of your property.