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Mortgage Corner

January 31, 2007

Equity vs. Debt?

This is a question we hear often. When considering a large purchase, such as a home or a second home, is it better to use a mortgage or pay cash? The answer depends on your unique circumstances, but here are a few things to keep in mind.

Equity Rate of Return

Consider a long-term rate of return for your investments. Don’t be too focused on short-term returns, be they positive or negative. This is a long-term decision and the most appropriate benchmark is likely a 10- or 15-year rate of return rather than what happened over the past 12 months.

Risk Tolerance

Paying down debt is a definitive step. You know exactly what your benefit is. Long-term equity returns may well be higher, but they will have variability to them over time.

Interest Rate Costs

Mortgage rates fluctuate over time. Currently, they are hovering around historic lows, but consider your long-term costs here as well. Many mortgage offerings are now variable and the rate you pay may change over the course of your loan.

Tax Implications

Currently, mortgage interest is deductible against ordinary income up to certain limits. Often equity returns may be taxed as long term capital gains and dividends. The tax on these types of income is currently capped at 15% and may be as low as 5%. This gives equity a tax advantage in many cases.

In summary, the decision is unique for everyone and may be one of your largest financial decisions ever. The best decision will be made by understanding the equity markets, the mortgage markets and the impact that each will have on your personal tax situation. Please feel free to contact me ksmith@sequoia-financial.com or Sequoia Financial Group if you have any questions or would like to discuss your personal circumstances.