Are Mortgages Good Debt?

There seems to be a widespread myth out there that mortgage debt is one of the best types of debt you’ll run across in your lifetime. Who’s perpetuating this myth? Politicians, the media, and (of course) realtors and mortgage brokers. It’s pretty clear why some of these folks might want John Q. Public to buy into this myth, but let’s take a look at some of their main selling points for mortgage debt.

  1. Mortgage interest is tax deductible. At the moment, this at least partially true. Congress continues to maintain the mortgage interest deduction as a valid deduction from federal income taxes (at least for now). But what you need to figure out before you start counting on that huge tax refund is whether it will even apply to you. We’re a married, childless couple, so we get two standard deductions on our taxes. That means in 2011, we were automatically given a standard deduction of $11,600. In order to get any benefit from the mortgage interest tax deduction, the mortgage interest plus all our other deductions needs to total more than $11,600. Here’s a link to an IRS page that helps you figure out if it’s worth itemizing deductions. Unless you have a HUGE mortgage or HUGE real estate taxes, or LOTS of medical expenses or charitable donations, you may have a hard time getting those numbers to add up to more than the standard deduction. Well… that is, if you buy a house that isn’t crazy expensive…
  2. Repayment is measured in decades. A standard 30-year loan at 5.3% is going to end up costing you just about double the original loan value by the time you’re finally done paying it off. Stretching the payment terms out that long, most people don’t stop to think what all that time is really costing them. That $150K house really ends up costing $300K without you even thinking about it.
  3. You can always refinance if rates lower. Luckily this myth seems to have been pretty solidly popped over the last few years. When home prices are strictly increasing, refinancing is easy and many even took cash equity out of their house, increasing the principal that they owed. Even though this came back to bite a lot of people when prices fell 30% or more, it doesn’t take giant market shifts to erase big portions of the equity that has been built up. And a healthy amount of equity is one of the main things you need to be able to refinance. (Our bank required 25% equity to refinance when we did it last year.) Consider the following – you’ve got a house that is worth $150K, and you owe $105K on it. Your equity is $150K-$105K=$45K, which is 30% of the $150K market value. That should be plenty of equity to refinance. But what happens if home prices drop just 10%? Now your house is worth $135K, and your equity is just $135K-$105K=$30K (a 33% drop from what you had before), and it represents just 22% equity in the $135K market price. That 22% equity might not be enough to allow you to refinance.

So politicians like you to think you’re getting a big tax break, when really all they are giving you is a very small reason to over-extend yourself and buy more home than you perhaps should. Mortgages brokers love it when you refinance because they get about $5,000 in fees every time that you do. And bankers love for you to forget just how many times you will pay for your house over the decades-long life of your loan.

Because of all these things, I have a really hard time saying that mortgage debt is “good”. It’s debt just like any other, and you need to be very aware of what exactly you’re paying for the luxury of that long-term payback.

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