The Great Mortgage Debate

Politics and religion – two topics to be avoided at work, social gatherings, and if you are looking to stay away from unwinnable discussions with soon-to-be former friends. I might add “mortgage advice” to that list. The real estate market has been on quite a tear recently, and with rising house values and historically low interest rates, the mortgage debates are stronger than ever.

Below are 4 of the more common statements (there are plenty more) I hear passionately debated regarding mortgages and real estate:

1. Mortgages are “good debt” since it is tax deductible and connected to an appreciating asset.
2. There is nothing better than a paid off house, or a 15 year mortgage is better than a 30 year mortgage.
3. 30 year mortgages are preferable to 15 year mortgages since I can invest the difference and earn more money.
4. Mortgages are a great hedge against inflation. 

I want to dive a bit deeper and share some thoughts.

1. Mortgages are “good debt” since it is tax deductible and connected to an appreciating asset.  When people refer to “good debt” this means debt connected with an asset that should go up in value. Since we like to be optimistic about the future value of our homes, mortgages may fit this definition. In regards to taxes, generally, you can deduct interest paid on a personal mortgage. This falls under the category of “Itemized Deductions” which, when taken together with other deductions such as charity, state taxes, and other less common scenarios, gets compared to the “Standard Deduction” and you typically deduct the larger of the two. For joint filers, the standard deduction in 2021 is $25,100 and for single filers it is $12,550. Additionally, under the 2017 TCJA, limits were placed on the amount of interest that can be deducted for very large mortgages and state tax deductions were limited to $10,000 per year.

Elliot’s Take: Mortgage interest is not as tax deductible as people believe*. Also, approval for a large mortgage, doesn’t mean you can afford a large mortgage and your taxes will drop. Large outlays (think tuition) do not go into the mortgage broker’s calculations. It is your responsibility to determine what works for your own cash flow!

1. There is nothing better than a paid off house, or a 15 year mortgage is better than a 30 year mortgage. I believe broad sweeping personal finance advice can do more harm than good. There are some calculations that should be made before you buy or decide to refinance your house. Yes, a 15 year mortgage leads to a lower total cost since the amount of interest paid is significantly lower. However, the monthly payment can be significantly higher.

Elliot’s Take: Consider all options across mortgage terms, and appreciate the trade off between a lower payment, but more interest vs. a higher payment, lower interest, and a quicker paid off house. There is no one size fits all solution in personal finance, so make sure to find the size that works for you and go for it!

1. 30 year mortgages are preferable to 15 year mortgages since I can invest the difference and earn more money. There are a couple of assumptions in this statement. #1) The return on investment from allocating the difference between a 15 year and 30 year mortgage will be higher than the total interest paid  #2) People are disciplined enough to invest the difference in a way that will achieve the returns assumed in point #1. I have worked with people that firmly believe in #1 but fail to follow through with #2 and with people that firmly believe in #1 but do follow through with #2. I have also worked with people that accept both #1 & #2, but use the difference to enhance lifestyle.

Elliot’s Take: I believe that while point #1 has a high degree of probability in today’s low interest rate world, point #2 is much easier said than done. At the bottom of the article I share my personal experience with this.

1. Mortgages are a great hedge against inflation. In an inflationary environment, a fixed rate long term debt should provide inflation hedge since interest rates tend to rise during this time, and you are “locked in ” to a comparatively lower rate. On the asset side, real estate has proven to maintain “real” (i.e. after inflation) value over time.

Elliot’s Take: Sure, a mortgage can be a hedge against inflation, but we have no clue what inflation will look like next month let alone over the next 30 years, so don’t justify more mortgage than your cash flow can support just because it can hedge against inflation.

We are in an extraordinary time for real estate in this country, and the decisions that we make with any purchase of this size impacts our financial well being in the future.

My Mortgage Journey (ending: TBD)

I have been living in my current home for just about 10 years. Here is my mortgage journey:

1. Purchased home with 20% down and a 4.25% 30 year mortgage.
2. Around 5 years ago I refinanced to a 15 year mortgage at a 2.5% interest rate. My monthly payment went up by ~$600.
3. Around 18 months ago I refinanced again to a 30 year mortgage at a 2.75% interest rate. My monthly payment went down by ~$800. I opened a brokerage account and have invested the $800 difference into a balanced portfolio of stocks (80%) and bonds (20%) every month. 

What’s next? Who knows…

I am happy that I spent time aggressively paying down my mortgage, then when interest rates dropped, I was able to refinance and (so far) maintained the discipline to invest the difference in a portfolio that I believe will return a rate higher than 2.75%. I choose not to think much farther than that…life is too exciting!

The decision to start saving and investing is yours, the “how” can be hard. We suggest speaking with a “fee only” financial planner operating as a fiduciary – having a CPA or tax background is a huge plus. Email commoncents@northbrookfinancial.com to schedule a free financial planning consultation with our team.

*This article does not constitute tax advice, please consult your tax advisor for more information about your situation.