As you guys know, we recently bought a new house. And a new house means a new mortgage. And a new mortgage means debt. And debt is bad, right?
Well yes…and no.
If you can pay cash for something (and by that I mean charge it to your credit card for the points and pay it off stat), then you should. Paying the bank to charge to lend you money is a loss, there’s no arguing that. But very, very few of us would ever be able to afford to buy a home if we always stuck to that rule.
Good Debt VS Bad Debt
Let’s say there is a sliding scale of awfulness when it comes to debt. Payday loans are the worst of the worst. They’re like the Charles Manson of debt. They are incredibly punitive, with interest rates often reaching 300% annually.
At the other end of the scale, you have mortgage debt. The significantly lower interest kind where you’re also building some equity (in a perfect world). That’s more like the guy who wears socks with Birkenstocks. No matter what the fashion trend of the moment may say, it’s a fashion faux pas but not much else.
In between the two extremes you’ve got other debt like student loans, car loans, low-interest credit cards, lines of credit, etc. Keeping up the totally accurate examples; this would be the school bully who made fun of you in elementary school for having hairy arms.
Why is mortgage debt good debt?
First, let’s clear up one thing. Good debt is better than bad debt, but no debt is better than both. There are a few positives with mortgages though, and reasons why having one might make perfect sense for your situation.
The biggest reason mortgages can be used to your advantage is because interest rates are low.
On a credit card, you could be paying upward of 19% interest on your purchases. For a mortgage, you’re likely looking at between 2% and 4% depending on when you got it. That’s a huge difference. That’s potentially an extra 17 cents on every dollar you’d be paying in interest charges. So yes, paying interest always sucks; but the lower the interest rate, the better the debt.
This is something to keep in mind as interest rates continue to rise. Us millennials have become accustomed to low mortgage rates, but that’s not the norm. Ask your parents if they remember what the interest rate was on their first mortgage. If they bought in the 80s, it was likely a lot closer to 15% than to zero. Sure, house prices were a lot lower then, but there’s nothing to say we won’t get back there eventually.
The Relationship Between Interest Rates and Rates of Return
You want to know that every dollar you earn is working for you. It could be buying your food, paying your rent, taking you to a show, going towards interest, or earning you even more. Your goal with budgeting is to balance these into a system that works for you.
A question that will often come up when you’re establishing a budget is:
‘Should I be saving or paying off debt?’
Debt is emotional, so you always want to determine your comfort level. Does it stress you out? If so then it’s almost always best to work on paying it off. If it doesn’t, then you want to look at the best use of your dollar. To do that you can compare how much you are paying in interest to how much you are earning in returns. If your mortgage is at 3% and your investments are averaging 7% per year, then it makes sense to keep investing. Obviously, past returns don’t guarantee future returns, but it’s a good rule to follow. Plus, you can always alter your plan in the future.
One of the advantages to buying your own home is that you are putting your money towards an asset you own, instead of towards someone’s else’s. There are many pros and cons to both renting and buying, but this is a big pro for buying.
The problem is that it can be a bit of a crapshoot. In case you need a reminder, the real estate market doesn’t always go up. And you can get yourself into big trouble by banking on that who equity building thing. Sometimes it works incredibly well. We just sold our home for $150,000 more than we bought it eight years ago. That’s not going to be the case for everyone. Even in our city, there aren’t that many neighbourhoods that have seen the same kind of growth. What can I say, we picked well 😉
If you understand the market you’re buying in, and are planning to live in a house long-term, there is a good chance you will build equity by purchasing a home.
The final reason I’m comfortable with my mortgage is that it gives me flexibility. I’m able to take a more balanced approach to my money because not every dollar is earmarked to pay off the house.
I can take advantage of the gap between my investment returns and my mortgage rate by saving more for retirement. If I were to delay retirement savings to focus on the mortgage, I would miss out on years of compounding! At this point, if I have to sacrifice my retirement savings or my mortgage, I’m going with my mortgage. That might not be the right choice for everyone, but for me, the math makes sense.
Let’s not forget about having some fun while we’re at it. At this point in my life, housing will always be a line item in my budget. It doesn’t matter whether that’s going towards rent or a mortgage. What does matter is that I can afford it and have enough money left over to save and still enjoy the things that make me happy?
To Sum Up:
Owning a fully paid off home would be fantastic, but that’s a pipe dream for many millennials. It’s a goal to work towards, but I don’t think it should take priority over other money goals like saving for retirement. Regarding debt, mortgages are the good kind because they allow you to take advantage of low interest rates, build equity and provide flexibility. Instead of thinking of your mortgage as the enemy, why not think of it as a tool?
What’s your take on mortgages? Are you comfortable keeping yours in favour of other financial goals? Or is it at the top of your priority list?
This post was proofread by Grammarly.