Mark 30, 2023

A typical school of thought in financial planning/management is that any debt is a liability.  Your car, your student loans, your credit cards, and your mortgage.  Some financial gurus have encouraged people to aggressively pay down or pay off all debts, including the mortgage.  Normally this is pretty sound advice, but it’s also “one size fits all” advice, and as it related to mortgages, it may be bad advice.  

Most debt is in fact bad and is in fact a liability.  Take cars, student loans, and credit card debt.  We can examine each one.  

Auto Debt

While you may require as a necessity in your life to have private personal transportation, owning a new car with a car payment is optional for most people.  A car payment is a luxury, not a necessity, and you are using debt for something that is rapidly losing value and will ultimately become worthless (most people get rid of their car before it reaches $0 value but ultimately it will be worth $0 if kept long enough). An older paid-off car can just as easily get you from A to B as a new $1000/month car, albeit maybe the ride would be less luxurious.  There is virtually no limit to the amount of cars that can be manufactured in a given year (thus no constraint on supply generally) so they are assured to depreciate pretty rapidly.  While auto debt is generally at a low, fixed rate (the best way to take on a debt), these debts are nonetheless liabilities and not an asset for reasons stated above.  

Credit Card Debt

Credit card debt is the most insidious form of debt due its usuriously high and variable interest rates.  Credit Card debt should only be used sparingly and in emergencies.  Credit via credit cards is a liability that will cost you well in excess of the original borrowed (charged) amount.  Charge Cards like American Express, or using a credit card for convenience and paying your balance in full every month is fine, as there is no debt being accrued.  

College Loans

College loans are a necessary evil for many younger Americans.  While a manageable college loan is not necessarily a “bad” debt, if you have a degree (an asset) that you can use for your career and hopefully pay off said debt in a manageable amount of time.  The issue is that once you graduate, these loans often take a very long time to pay off or down, and the fact that is more and more people obtain college degrees, the degree itself is de-valued.  In other words, it’s harder to obtain a job or career with the degree that once was able to be attained, thus the question of whether it is good or bad debt arises.  While these loans are low interest and fixed rate, In general it should be paid off as soon as possible.  College loans are considered a liability when it comes to debt and financial planning/management.  

Mortgage Debt

Mortgage Debt isn’t always an asset but when employed correctly it can be.  Mortgage debt isn’t an asset when the mortgage payment exceeds what the estimated rent would be for the property.  This implies that not only could you rent the same house for less (in this case renting would be better), but if you were forced to move out and rent the house out, you’d be losing money each month.  This would be considered a “bad” mortgage or an “expensive” mortgage.  There are occasions where adjustable rate mortgages are bad mortgages.  If you are stuck with a mortgage during a massive shift in the “prime rate,” where the index for your adjustable rate changes, this can turn a good mortgage into a bad one very quickly.  When used shrewdly, ARMs can be wonderful; they can also leave you exposed.  I’ve seen examples where a buyer gets into a house with a lower rate using an ARM and is able to then refinance (without penalty) several years later into a 30 year fixed rate mortgage.  It’s almost like double dipping; It’s a thing of beauty when it works!  There are other times when the ARM adjusts much higher before the borrower has any option to refinance and then at that point the options are more limited.  

For the purposes of this post though, anyone sitting on a 30 year fixed rate mortgage in the 2%’s or even in the 3’s%, this mortgage is an asset of yours and here’s why.  

According to a recent Yahoo article, Although rates are down from their 7.37% peak, the 30-year fixed mortgage rate came in at 6.57% on Monday. According to Goldman Sachs, 99% of borrowers have a mortgage rate lower than 6% (or the current market rate). Of those, 28% locked in rates at or below 3% and 72% locked in rates at or below 4%.

That right, nearly 30% of homeowners have a mortgage rate below 3%.  This is a huge asset with inflation running 6%+.  

In an era of high inflation, everything goes up quite a bit year over year, as measured by the CPI (consumer price index).  But that’s not even the best part.  The CPI largely doesn’t even take into account housing, where real estate prices have (up until the past 6 months anyway) been going up over 10%+ per year, and rent inflation trending the same way.  With a 30 year fixed rate mortgage, your principal and interest payment is fixed for an incredible 30 years.  

Let’s say that right now you have a $3,000/mo house payment and a 3% rate, and to rent an equivalent house would cost you $3,500.  It’s quite conceivable that in 10 years, rent would be $5,000/mo, whereas your P&I payment is still the same at $3,000/mo.  Maybe you could convert that house to a rental and cash flow $2000/mo if you wanted to.  Likewise, maybe the 30 year fixed rate mortgage in 10 years is 10% or 12%.  

As the short term and long term rates trend up, it doesn’t matter to you, because you have a fixed rate for the life of the 30 years.  Excess money that you earn or excess money that you had when you bought the house, which you chose to not sink down on the down payment, can be deployed on investments at much higher rates of interest.  Risk-free investments right now are paying upwards of 5%, such as a 1 year treasury or Bank Certificate of Deposits.  It’s conceivable that you may be able to get 6%,8%, even 10% return relatively risk-free in the future, while having your biggest debt fixed at 3%.  I don’t believe this type of interest-rate arbitrage has been available ever in history.  

In a high rate environment this is excellent advice. If you have a sub 3% loan – it’s a little less attractive.

Let’s assume you have a 2.69% interest rate (my actual rate) and you haven’t paid a penny on your mortgage. And let’s assume your mortgage is $800k (California isn’t… https://t.co/x4qkzWKfcZ

— Kevin Lum, CFP® (@kevinlum) March 27, 2023

You are hedging inflation with your mortgage, which you used to buy an appreciating asset (the house).  It’s a win-win.