Uncovering the Truth: Is a Mortgage Bad Debt?
If “debt is bad” why are mortgages OK? This is a question that has been puzzling many potential homeowners for decades. While we’d all love to pay for houses in cash, it’s not always realistically possible, and mortgages are just really a common part of the financial landscape. Can mortgages actually be financially beneficial or destroy your financially wellness? We often hear conflicting messages.
With the current economic climate, this question has been brought to the forefront and it is time to uncover the truth about mortgage debt. Let's take an in-depth look at why mortgages can actually be "good debt", why and when they can be considered "bad", and how they compare to other types of debt.
What Is A Mortgage?
The ideal way to buy a house is to pay 100% of the cost up front. That means paying cash for the entire house. Sounds weird, doesn't it? But think about how freeing it would be to have no mortgage payment! If paying cash for a house seems too far out of reach, getting a mortgage isn't a horrible idea.
A mortgage is a type of loan used to finance the purchase of real estate property. In exchange for providing the funds, the lender (bank) holds a lien on the property, which means that if the borrower defaults on or cannot make their payments, the lender can seize and sell the property to recoup their losses. Mortgages typically have fixed or adjustable interest rates and can be repaid over several decades, depending on the terms of the loan.
While some people view mortgages as bad debt because they involve borrowing money and paying interest, others argue that they are a necessary part of homeownership. Mortgages enable people to buy homes that they might not otherwise be able to afford and build equity over time. And unlike miscellaneous debt like credit cards, lines of credit, personal loans and other debts that are not associated with any particular loan product, mortgage debt is secured by a home or other real estate. In the event of default, lenders can foreclose on the property and recoup their money through the sale of that asset. In many cases, however, foreclosure is avoided by negotiating mortgage modifications with lenders.
It's important to note that whether or not a mortgage is considered "bad debt" may depend on individual circumstances such as income level, financial goals, and risk tolerance. Ultimately, borrowers should carefully consider all factors before deciding whether or not to take out a mortgage and how much debt they are comfortable carrying.
Benefits of a Mortgage
A mortgage is often considered the largest debt a person or a couple will ever take on in their lifetime. However, it's important to understand that not all debt is bad debt. In fact, a mortgage can provide several benefits that outweigh the potential drawbacks.
One of the primary benefits of having a mortgage is building equity in your home. As you make payments towards your mortgage, you are essentially investing in your property and increasing its value over time. This can be particularly beneficial if you plan to sell your home in the future or use it as collateral for other investments. But the type of home you're investing in determines the amount of equity. Some homes - like RV's or trailers - don't usually increase in value. So it's important to have a good idea of the equity potential a property has before locking into a mortgage or loan.
Another advantage of having a mortgage, albeit a small one, is the tax deductions that come with homeownership. Mortgage interest payments are generally tax-deductible, which can help reduce your overall tax burden and increase your disposable income. That said, paying cash for a house will always be financially wiser.
Finally, having a mortgage can provide peace of mind by providing stable housing for you and your family. Unlike renting, where landlords may raise rents or choose not to renew leases at any time, owning a home with a fixed-rate mortgage means that you have predictable monthly housing costs and control over how long you stay there. The amount of time you stay in a home with a fixed-rate mortgage is entirely up to you.
How much will my mortgage payment be? To determine how much you can afford to spend on a house, it's important to consider your current monthly expenses along with your projected expenses. Applying a down payment of at least 10% on a 15-year (or less) fixed-rate mortgage, and limit your monthly payment to 25% or less of your monthly take-home pay, is the wisest decision.
RISKS of a Mortgage
One of the most significant risks associated with a mortgage is the possibility of defaulting on payments. If a borrower fails to pay their mortgage, they risk foreclosure and losing their home. This can be devastating not only for the individual but also for their family, especially if there are children involved.
Another risk associated with mortgages is the potential for interest rate hikes. Even though fixed-rate mortgages provide some level of stability, adjustable-rate mortgages (ARMs) are subject to interest rate variations that can increase monthly payments significantly. In addition, market fluctuations can lead to property values decreasing, which could leave homeowners underwater on their loans.
Lastly, taking out a mortgage means being in debt for an extended period of time. While some may argue that having a mortgage is good debt because it's an investment in property ownership, it's still debt nonetheless. Borrowers must take into account whether they can afford the monthly payments over the long term and how this will impact other financial goals such as retirement savings or emergency funds.
Types of Mortgages
There are several types of mortgages to choose from when buying a home. The most popular type is the fixed-rate mortgage, which locks in your interest rate for the entire loan term. This makes budgeting easier as your monthly payment stays the same. Another type is the adjustable-rate mortgage (ARM), where the interest rate can change over time, potentially resulting in lower payments initially but higher payments later on.
Government-backed mortgages are also available, such as FHA loans and VA loans. FHA loans require a lower down payment and credit score than conventional mortgages, while VA loans are exclusively for veterans and active-duty military members with no down payment required. Additionally, there are jumbo loans for amounts exceeding conventional loan limits and balloon mortgages that offer lower initial payments but require a large final payment at maturity.
It's important to consider all options before choosing a mortgage that fits your financial situation and goals. Talking with someone who’s had mortgage experience, along with a lender, are great options to really understand what type of mortgage would be best for your situation. And food for thought, just because you may be approved for a certain amount, doesn’t mean you should use all of it. The rule of thumb is to not use more than 25% of your take home pay on housing (mortgage, taxes, insurance, and PMI - all together).
It's clear that mortgages can be seen as both good and bad debt depending on the situation. In order to make an informed decision, careful research and budgeting must be done in order to determine whether or not a mortgage is right for you. It is essential to keep in mind that regardless of what type of debt it is, all debt must be paid off responsibly and on time in order to avoid any long-term negative effects.
There is no single answer to the question of whether a mortgage is bad debt or not. It depends on individual circumstances and financial goals. The decision to buy a home with borrowed money should be made carefully, after careful consideration and research. A good rule of thumb is to borrow only what you can comfortably afford. When making the decision to take out the biggest loan you’ll probably ever have, it’s incredibly important to be financially healthy and research all your options ahead of time. If you’d like to see really how much you can budget, talk to a Financial Coach and get on track.
