One of the major problems leading to the housing bust a few years ago was the idea that everyone deserved a home, even if they couldn’t really afford it. This myth was further propagated by cheap credit and the push that mortgages were good debts to have.
But can this really be true? Can any debt truly be a “good” debt? You are paying interest and signing up for years of payments. How is that good?
The Positives of Having a Home Mortgage
Here are a few reasons your home loan could be a good debt.
Inflation Works For You
The best part of buying a home with a long term fixed rate mortgage is that your payment is locked in for the term of the loan. That means your $1,000 payment today will be $1,000 in 30 years. At first you might be stretched a bit from the payment, but over time as inflation creeps up the cost of your payment should go down in terms of your out of pocket costs. The actual payment stays the same, but you should have extra dollars each year as your income adjusts for inflation.
This only works over a long term loan like 15 or 30 years. If you only stay in the home 5 years you won’t see much difference in your income just due to inflation, so your payments won’t feel significantly smaller. (Also, if you change homes every 5 years the price of the homes will be going up with inflation which negates the positive side of inflation for you.)
Letting inflation work for you can also be seen if you compare to renting. Rents have historically risen with inflation, so if you always rent your rent costs should keep going up with inflation. You can’t lock in your payment like you can with a mortgage.
Consistent Payments Build Credit Score
Consistently paying your mortgage can do great things for your credit.
35% of building up a solid credit score is having consistent payments with no late or missed payments. A mortgage is a significant debt, but having one for years that you pay on time will slowly build up your credit score. You’re showing creditors that you are reliable and can be trusted with future credit.
15% of your credit score comes from length of credit history. If you have a mortgage for years you are increasing how long you have had a credit account.
These two factors alone make up 50% of your credit score. Increasing your credit score will reduce your interest rate costs.
You Don’t Have to Wait Decades to Pay Cash
Of course the most simple positive of using a mortgage to buy a home is you don’t have to wait decades to save up to pay cash for a home. It could take you 15 or 20 years of saving to be able to purchase something worth several hundred thousand dollars. (There are also some non-financial perks to living in a home versus in a rented apartment that should be considered.)
When Your Interest Rate is Practically Nothing
When interest rates are at rock bottom — when there are new historical lows every month — then borrowing the cash over the long term can be a smart decision. However, this kind of debt is really more of a gamble. The idea is if all of the other conditions are right (you can afford the house, you plan to stay long term, and so forth) then getting a low rate allows you the opportunity to earn higher rates of returns on the rest of your money. If you can only put 20% down on a house that frees up the cash you would have had to save to pay cash for investment purposes. If you can pull this off then it is a good thing, but it is also risky because we’re talking about thousands of dollars at risk.
When a Mortgage is a Bad Debt
Anytime you’re talking about hundreds of thousands of dollars, things can go bad quickly. Here are few ways your mortgage can be a bad debt.
Buying a House You Cannot Afford
Of course one of the main drivers of the housing bust was an entire section of the population buying homes they could not afford. Whether it was no documentation loans, 125% financing, or simply buying too much house there were errors committed everywhere.
Buying too much house at a cost you cannot afford definitely makes your mortgage a bad debt. You’ll pay too much interest at best. At worst you end up being foreclosed on or having to short-sale.
Nothing good comes from buying a house you cannot afford.
Buying a Home You Won’t Stay In
Likewise, your mortgage shouldn’t be considered a good debt if you don’t plan to be in your home for a long time. There are multiple reasons this pushes you into bad debt territory:
- You will likely take a huge loss when you sell your home from market fluctuations, realtor fees, or both.
- Approximately the first 10 years of a 30 year mortgage are primarily interest. If you never live in the home for the remaining 20 years you are always paying maximum interest and minimum principal on your loan.
- If you buy a new home every few years you end up paying a lot of extra money in closing costs for each mortgage.
A mortgage only has the chance to be a good debt if you hold it for a long period of time.
When It’s a Rushed Decision
Spending more than $30,000 on anything should be something that you take a long hard look at. Buying a home is likely to be the largest financial transaction of your entire life. You’re spending hundreds of thousands of dollars and promising a financial institution that you are able to make payments for decades at a time.
Yet the home buying process often feels like a rushed decision. It is easy to fall in love with a house and not take all the necessary factors into consideration before making an offer before someone else can. We think the one good home we find is the home, that no other home in the area exists that we can buy. Rushed decisions end up being expensive decisions in most cases. Rushing leads to less shopping around not only on the actual home, but the loan company, insurance company, and so on.
Wouldn’t you rather take your time to spend several hundred thousand dollars?
All debt is bad debt. You’re paying interest because you couldn’t afford to pay cash for something.
Yet if there were ever a debt that could be considered good, a mortgage would be it — if the conditions are right:
- You have to hold the mortgage for a long time for it to pay off.
- You can’t pay too much for the house to start with, and you have to be willing to stay put.
- The interest rate needs to be low to make borrowing the cash long term a worthwhile gamble.