Home Mortgages: The Debt Exception

If debt is slavery, is there any time, under any circumstances, where it ever makes financial sense to borrow money? I can only think of one: It’s okay to take out a mortgage when you buy a house, but only if you do it the right way.

We’ve made no secret of our disdain of debt on this site, and we’re passionate about teaching people to break the bad money habits that keep them in the hole. It would be easy to make an across-the-board rule that all debt is bad, all the time. And the truth is that consumer debt is always bad — things like car loans and credit card balances are always a mistake. But buying a home is a different matter entirely. The rules of home mortgage are very different than the rules of consumer debt, and they call for a new strategy.

If you have the tens or hundred of thousands of dollars necessary to buy a house outright, then by all means, pay cash. But if you’re like most people, you don’t have anywhere near that kind of money, and it would take you a long, long time to save it. There are a lot of financial advantages that come with home ownership, and we’d rather see you buy a home earlier in life than later. Mortgages — the large loans we use to purchase houses — make home-buying possible, and they work so differently from consumer debt that we can learn to use them in a way that isn’t dangerous.

There are three key things that make mortgages and home-buying different than consumer debt. Take these points into consideration when you plan your family’s housing strategy.

1) Mortgages are secured debt.

When you borrow money to go to college, or put household expenses on a credit card, you’re essentially taking out an unsecured loan. The bank is lending you money in good faith, under the expectation that you’ll pay it back. But you can’t sell your college degree to get back the money you spent and pay back the loan, and you can’t return a restaurant meal to pay off the charge on your credit card. If you get in over your head and have trouble making your payments, the bank is going to come after you and take any asset they can get their hands on, maybe even forcing you into bankruptcy.

Home mortgages, on the other hand, are secured loans. The money that you get is tied directly to the property that you buy. If you don’t want to pay the loan anymore, you can simply sell the property, give the money back to the bank and walk away unharmed. When you use wisdom in the way you mortgage (by putting down 20% of the home’s value in cash and not borrowing more than you can afford to pay each month), you virtually ensure that you’ll never be upside-down on the property. Your home should always be worth more than you owe on it, so you always have an escape valve if you come to a point in life where you can’t make mortgage payments (or simply don’t want to).

2) Homes rise in value.

Almost everything that Americans use debt to buy declines in value — cars, furniture, grown-up toys and luxury items all begin depreciating the moment you bring them home. This can create a dangerous debt situation, where you owe more on an item than it’s currently worth.

Homes, on the other hand, are one of the only things that we buy that actually rise in value after we buy them. In a stable economy, homes can appreciate by 3%-5% each year. (Note, the economy of the last 4 years has not been stable, nor is it a reflection of what a normal economy looks like. Don’t be scared by what amounts to a temporary situation.) If you buy a home with 20% down, that means that you’re paying interest on 80% of the house’s value; when the value of the house appreciates, however, you earn equity on 100% of the house’s value. That difference between 80% and 100% can mean that your equity gains come close to negating the money that you lose in interest payments. Home mortgages are the only type of loans that offer this kind of financial upside.

3) Mortgages allow you to lock in your home’s price and interest rate.

Let’s say that there’s a house you’d like to buy that costs $150,000. If you wanted to pay cash for that home, you could perhaps save that much money over 10 years. But you’d have a problem: Since homes appreciate over time, that $150,000 home could cost $201,000 (assuming a conservative 3% per year appreciation). You will have spent 10 years renting and saving, and still not have nearly enough money to buy the house that you want.

When we take out a mortgage to buy a home, on the other hand, we lock in the price of the home at today’s values, and protect ourselves from inflation. True, you’ll pay some money in interest on your mortgage, but some of your monthly payments will also turn into equity in the home. When you rent a home, you get no equity — you’re just kissing money goodbye every month. So instead of “losing” money on rent for years, and losing home-buying power as inflation and appreciation drives prices up, taking out a mortgage to buy a home allows us to lock in the cost of our housing for the long term (as consumer prices rise, your housing prices stay flat). You also begin to turn that home into a valuable asset.

There’s still a lot to think about when taking out mortgages and buying homes. There are some great strategies that will help you to be financially shrewd, and some big pitfalls to avoid along the way. We’ll examine these ideas in future articles.


Photo by Images of Money. Used under Creative Commons License.

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