The logic seems to be that, because some debt is bad for personal finances, ALL debt must be destroyed as quickly as possible.
“All debt is bad debt,” you’re told by a circus of net-only finance writers.
That line of reasoning is analogous to showering in bleach because it’s the only way to kill all the bacteria festering on your skin.
But just as there are both beneficial and detrimental bacteria, there’s both good debt and bad debt. Yup, you gotsta kill the bad stuff. But some debt is really good for you. Like how some bacteria keep your gut microbiome going strong. And like how showering in bleach is pretty dumb.
So stop gargling with Clorox. Get out of the peroxide tub. Don’t deal with debt the same way bleach deals with prokaryotic microorganisms.
And especially don’t listen to the wacko advice creeping around on personal finance sites telling you to pay more than the absolute minimum on your mortgage payments each month. This is absolutely, 100% wrong. It will only damage your financial situation in the long run.
Mortgage debt is good debt – so long as the home purchase is a reasonably budgeted and the mortgage payments are able to be serviced effectively.
Those who advocate for paying mortgage debt down aggressively have a fundamental misunderstanding of finance.
They’re steering you the wrong direction.
They need to stop drinking the bleach.
I’ve written about mortgages before here on FinanciaLibre. They’re a big part of people’s financial situations, they represent huge chunks of people’s balance sheets, and they can be confusing.
So mortgages are a natural place for old FL to step in and throw around some elbows and knees.
But the first couple rounds in the ring didn’t seem to sufficiently lay waste to some misconceptions about mortgages. So now we’re back. Specifically, it’s two things that return us to this discussion.
First, I keep seeing real special web-only personal finance articles that go totally postal about mortgage debt. (Not to mention making senseless blanket statements like “All debt is bad debt!”) The authors often then describe the bizarre lengths they go to in paying off their mortgages early.
Some don’t heat their houses in the winter. Others have established elaborate “money envelope” systems that I don’t fully understand to somehow pay more toward the house each month. And others seem to have subordinated all other pursuits in life for the single-minded objective of removing mortgage debt from the balance sheet.
This is categorically stupid.
These poor people are killing themselves. And they’re making themselves poorer for all their convoluted efforts. They’re running faster and faster – but they’re not even staying in the same place. They’re falling behind BECAUSE they’re running faster and faster.
Second, I see stuff on Twitter about paying off mortgages all the time. One tweet in particular has stuck with me because A) it was amazingly off-target, and B) it got like a million heart things or likes or whatever Twitter calls clicks of approval.
Now, the combination of dumb and popular isn’t so surprising these days. But that doesn’t mean we have to stand for it.
Tweet, paraphrased (I’m not really sure how to search for old Tweets):
“If I hear one more person with a mortgage tell me they’re not in debt, I’m going to scream! That’s debt! You need to pay it off! ! ! –Twitter peep
Yes, debt does have that peculiar feature where it eventually has to be repaid. But if the leveraging effect of the debt is beneficial (i.e., profitable), then it has positive economic value and you want to keep it around as long as possible.
That’s basic finance. Maybe put down the Twitter and pick up a textbook. Maybe try less talking and more not talking.
The 30Y leaves people much wealthier than the 15Y as long as the freed-up cash associated with the 30Y’s lower monthly payment is smartly invested (in, for instance, equities). Depending on the time horizon, etc., 30-year mortgagees end up around $400,000 wealthier than 15-year mortgagees.
We also looked at some other mortgage-related scenarios here and here.
But now I want to address the question slightly differently to illustrate in arguably more tractable financial terms just how damaging an accelerated payoff schedule for a mortgage can be.
Let’s do it like this.
We’ll start with all the same assumptions as used in our previous mortgage comparison: A $400,000 home purchase price (which is reasonably budgeted for our hypothetical buyer); 20% down (so no PMI); interest rates as of Aug./Sep./Oct. 2016; eligibility for the mortgage interest deduction at a 25% marginal tax rate; etc. For a full review of assumptions, check out the earlier post where they’re discussed in full.
For this analysis we’ll look at a 15-year time horizon. And we’ll once again compare a 30-year mortgage minimum payoff schedule with a 15-year mortgage minimum payoff schedule. (That is, the 15Y mortgagee pays off the loan at twice the rate of the 30Y mortgagee. And the 30Y mortgagee, as a result, incurs greater interest expense.)
But we’ll throw in a twist to the analysis. We will no longer assume that the 30-year mortgagee invests into equities ALL the excess cash flow available as a result of the 30Y’s lower minimum monthly payment.
Instead, we’ll determine how much more money the 30Y mortgagee could spend – willy nilly – on stuff, vacations, charities, hair salon treatments, whatever fits their personality… and STILL end up wealthier after 15 years than the 15Y mortgagee who pays off the house at twice the necessary rate.
Let’s cut right to the chase here. The answer is about $32,400.
Or a little more than $2,160 per year.
That’s how much more money a person could literally throw into a bonfire and still end up wealthier…simply as a result of NOT paying down mortgage debt faster than necessary.
Think of all the crap you could buy for $2,160 per year! You could get like 5 new flat-screen TVs. Every year! That’s more than one new TV each calendar quarter! Wowza! So stupid! And still so wealthy!!
Or whatever. You don’t have to buy TVs. You can do other stuff. After all, a little over $2k is a lot of money.
All those people killing themselves to pay off their mortgages faster than necessary could actually heat their homes during winter for a change! And have enough left over to still buy some new TVs. And get rid of the money envelopes they have squirreled away in various parts of the house. And still end up richer than they’d be by killing themselves to pay off their mortgage at an accelerated pace.
These people could stop selling all their free time to “side hustles” or second jobs. They could, like, totally take the easy road to happiness and wealth. You know, like, without trying real hard. And, like, with the heat running in January. And, like, you know, by just using basic finance to not be stupid. And also not listening to clowns who can’t understand why bathing in bleach isn’t recommended by most healthcare professionals.
So how’d I do this calculation?
First, let me disclose that I cut one corner that serves to understate how much better off the slow-pay mortgagee ends up. Specifically, I compared a 30Y mortgagee who pays the minimum with a 15Y mortgagee who also pays the minimum. Which means the 15Y mortgagee pays a lower interest RATE (because shorter-duration loans command lower APRs).
The amount of extra cash a slow-pay mortgagee could burn and end up wealthier than a fast-pay mortgagee is much bigger if it’s assumed both have the same interest rate – as would be the case with a 30-year mortgage-holder who pays down more each month than needed.
That 30Y v. 30Y scenario’s plain ugly. So we won’t even go there. (Let’s just leave it at this: If you’re paying more than the required minimum on your mortgage each month, regardless of whether it’s a 15Y or 20Y or 30Y, you are just chugging bleach like it’s being poured down a two-story beer bong. Which is totally rad until it kills you.) And, besides, comparing the 30Y and 15Y gets the idea across. And we wouldn’t want to offend anyone.
So here’s the basic math. I used the same worksheets as in previous mortgage investigations. Using those calcs, I found the 30-year mortgagee’s investment rate on the excess cash that would cause that mortgagee’s total wealth outcome to equal the 15-year mortgagee’s total wealth outcome after 15 years. In other words, because the 30Y mortgage requires lower monthly payments than the 15Y, the 30Y mortgagee has excess cash on-hand each month to invest rather than pay into the mortgage. I asked how much of that excess cash could be spent rather than invested and still leave the 30Y mortgagee wealthier than the 15Y mortgagee after 15 years.
The investment rate that just about makes them even is 77.25%. So, the 30Y mortgage could spend over 22% of the excess cash available to the 30Y mortgagee over the 15Y mortgagee and still end up with greater wealth. Meaning the 30Y mortgagee could burn a bit more than $2,160 per year…and STILL be richer than the fast-pay mortgagee after 15 years.
After 15 years, that’s a grand sum of around $32,400 that the 30Y could spend without any relative wealth penalty.
All right. So there you go. It’s that easy to grow your wealth by not killing yourself to pay your mortgage faster than necessary.
But there are some caveats that warrant mention.
If you can’t afford a house, don’t count on mortgage debt to somehow save you. The leveraging benefit of mortgage debt depends upon the mortgagee being able to service that debt. The alternative, of course, is bad. Like bankruptcy or eviction and stuff. But let’s be clear: It’s not a mortgage that causes problems like this; it’s buying a house that’s too expensive.
If your mortgage payment doesn’t allow room for savings and investment, you can’t afford the mortgage. Which means you can’t afford the house. Which means you shouldn’t buy it.
Mortgage debt is beneficial because the effective interest rate paid on a mortgage is so low relative to the returns the borrowed money can obtain in investments like equities. Which means the leveraging benefit depends upon there being excess monies available to invest in wealth-creating assets like equities.
If you couldn’t afford the monthly payments associated with a 15-year mortgage on your house, then the house is too expensive for you.
1) Find a cheaper house.
2) Then get a 30-year fixed mortgage on it.
3) Invest in equities the difference between what you’d have paid with the 15Y mortgage and what your actual payments are on the 30Y.
4) And celebrate that you understand the difference between a quasi-consumption good/terrible investment (housing) and an actual investment (equities).
Now, tax distortions, low interest rates, the long duration of the loan and the fact that housing tends to mildly appreciate in value over time enable beneficial long-run leveraging via mortgages. These same effects are not present in other types of debt – like auto loans or credit card debt.
So don’t go thinking that, just because long-run mortgage debt will help you build long-term wealth, you’ll get the same effect with other debt types. You won’t. Other debt works in the opposite direction. That other debt you should kill, or else it’ll kill you. Pour some bleach on it.
And there you have it, Luchadores. A simple way to build wealth while raising your standard of living all along the way. And all you had to do was ignore a few ruinous web-only PF articles and some stupid Tweets! Oh, and not drink a bunch of Clorox. Cheers!
Luchadores, am I being too kind to those who populate the internet and Twitter with ruinous advice that may be costing good people tens of thousands of dollars? Or should I throw some more elbows? Holla!
Theme by MyThemeShop.
Unless you've been living in a cave and receiving FinanciaLibre updates solely by smoke signal and carrier pigeon, you already know what this is going to say. FinanciaLibre is a blog. On the Internet. It can't be trusted to provide answers to all life's troubles. It won't un-click the buttons on your keyboard or cellphone when you're making a ridiculous error. It's only here to entertain, provoke, motivate and, from time to time, inform. You're the captain of your own financial dinghy. Not FinanciaLibre. FinanciaLibre does not provide financial advice, legal advice or medical advice. FinanciaLibre is not a certified public anything. It's not a religion. It's not even a real word. Your decisions, actions, victories and losses are your own. FinanciaLibre's not responsible for anything you say, do or eat. Own your decisions, Luchadores.