Why Mortgages Are Different From Other Kinds of Debt
Every corner of the personal finance world seems to hammer home the same point: Debt is the wealth killer. Debt is the single greatest threat to your retirement planning, college savings, and financial independence.
It’s a mantra repeated so often that it’s easy to believe that all debt is created equal. However, as it turns out, there is one kind of debt that defies all of these rules: mortgages. Money you owe on real property can, in fact, can enhance your financial independence in a lot of ways.
While we’ve seen the recent financial trouble that occurs when people finance their lifestyles using the value of their home, there’s no reason why you shouldn’t see mortgages as a reasonable and realistic financial tool to build your wealth. Let’s dive deeper into the reasons why mortgages are different from other kinds of debt.
Improve Credit Score
Having a mortgage can improve your credit score. Mortgages are seen as “good debt” by creditors. Because it’s secured by the value of your house, lenders see your ability to maintain mortgage payments as a sign of responsible credit use. They also see homeownership, even partial ownership, as a sign of financial stability.
Since 2009, credit scoring agencies have added points for consumers who are able to manage different kinds of debt. Having a house payment that you pay each month makes you look like a better, more responsible user of credit. It demonstrates your ability to handle long-term financial commitments and builds a positive credit history over time.
Housing Interest Rates
It’s the lowest interest rate loan you’ll ever get. Home loans are among the safest types of loans that lending institutions can issue. If there’s a problem during the life of the loan, the real property is a guarantee that the loaned money can be recovered. As a result, mortgage rates generally track the “prime” rate – the interest rate the Federal Reserve charges institutions to borrow money from them.
This low-interest rate makes mortgages an attractive option for borrowers looking to finance a home purchase. Compared to other types of debt, such as credit cards or personal loans, mortgages offer significantly lower interest rates, resulting in potentially substantial interest savings over the life of the loan.
You can make money by borrowing money to invest in something that will earn more than 4%. This is a good way to build wealth without spending too much. This deal has some risk. However, it is likely safer than withdrawing money from a 401(k) or IRA to invest.
By leveraging the power of your mortgage, you can access funds for investment purposes while keeping your retirement savings intact. This strategy allows you to potentially earn a higher return on your investment while benefiting from the long-term appreciation of your property value.
Favorable Tax Treatment
Buying a home can get you preferential tax treatment. The interest you pay on your home loan is generally tax-deductible, which puts it in a class of debt by itself. The government wants to encourage homeownership and is therefore willing to offer you a tax break for the financing costs of your mortgage. This tax treatment makes mortgages potentially even less expensive compared to other forms of debt. By deducting mortgage interest from your taxable income, you reduce your overall tax liability and keep more money in your pocket.
Secure and Safe
Home mortgages are proof against volatility. If you’ve got a fixed-rate mortgage, you can make plans around the amount you pay each month. If inflation accelerates, your payment stays the same. If interest rates skyrocket, you’re protected from that, too. If interest rates drop, you can usually refinance to save money.
Whatever happens, your house payment is locked in to protect you from uncertain economic times. This stability and predictability make mortgages a reliable financial instrument, allowing homeowners to budget effectively without worrying about fluctuations in interest rates.
It’s also a safe emergency fund. While you want to keep some money in a savings account to protect you from minor emergencies, you can use the equity in your home to protect you from major events. If you can get more than a 4% return on your investment, you’ll make money by keeping a home equity line of credit as an emergency fund and pursuing returns with your savings.
The equity in your home can serve as a financial safety net, providing you with access to funds during times of unexpected expenses or financial hardship. It offers a source of liquidity that can be tapped into when needed, giving you peace of mind and the ability to navigate challenging financial situations.
It can also serve as a source of retirement income. So-called “reverse mortgages” are increasingly popular among retirees whose portfolios are struggling. Functionally, you take out a mortgage on your home, and the lending institution pays you a set amount every month. Usually, the loan doesn’t come due until you pass on or vacate the home.
That way, the proceeds from the sale of the home, along with life insurance and other death benefits, can be used to pay off the debt. Mortgages can help finance your retirement by providing a regular income stream without the need to sell your home. This option allows retirees to tap into their home equity while maintaining ownership and the ability to live in their home.
Mortgage payments contribute to equity and homeownership, thus to your wealth. Unlike other types of debt, such as credit card debt or personal loans, mortgage payments allow you to build equity in your home. With each monthly payment, a portion goes towards reducing the principal amount you owe, increasing your ownership stake in the property.
Over time, as you make consistent payments and the value of your property appreciates, you can build substantial equity. This equity can be tapped into through refinancing or a home equity loan, providing you with additional financial flexibility or the ability to fund other goals such as home renovations, education expenses, or debt consolidation.
Mortgage debt is tied to a tangible asset. When you take out a mortgage, the debt is secured by the property itself. This means that if you are unable to make payments and default on the loan, the lender has the right to foreclose on the property and sell it to recover the outstanding debt. The fact that mortgages are backed by real estate makes them less risky for lenders compared to unsecured debts.
As a borrower, this provides you with leverage and negotiating power when seeking favorable terms and interest rates. It also gives you a sense of security knowing that your home serves as collateral for the debt, which can provide peace of mind and stability in your financial planning.
Hedge Against Inflation
Mortgages allow you to hedge against inflation: One significant advantage of mortgages is that they can act as a hedge against inflation. As inflation rises, the value of money decreases over time. However, when you have a fixed-rate mortgage, your monthly payments remain the same throughout the loan term. This means that as your income increases with inflation, the relative burden of your mortgage payments decreases.
Essentially, you’re paying off your debt with less valuable dollars. This inflation hedge can be particularly beneficial in the long run, as it helps preserve your purchasing power and ensures that your housing costs remain relatively stable compared to other expenses that may rise with inflation.
Access to leverage and real estate appreciation: By obtaining a mortgage, you can leverage your investment in real estate. Let’s say you purchase a property with a mortgage and the property appreciates in value over time. The increase in the property’s value benefits you as the homeowner, even though you only contributed a portion of the purchase price upfront.
This leverage allows you to potentially benefit from substantial returns on your investment. Real estate has historically shown long-term appreciation, and by using a mortgage, you can participate in this growth while using less of your own capital.
The psychological and emotional value of homeownership: While not strictly a financial advantage, homeownership carries significant psychological and emotional benefits. Owning a home provides a sense of stability, security, and pride. It allows you to establish roots in a community, create a living space that reflects your personal style, and enjoy the freedom to customize and make home improvements as you see fit.
Homeownership often fosters a stronger sense of belonging and connection to your neighborhood and can contribute to a higher quality of life overall. These intangible benefits, though not directly related to financial wealth, are an essential aspect of why mortgages and homeownership are different from other forms of debt.
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Mortgages stand apart from other kinds of debt due to their unique characteristics and advantages. Investing in real estate can benefit you in many ways. It can improve your credit score, give you low-interest rates, help you build wealth, and offer tax benefits.
It also provides stability and protection during economic changes, acts as a safe emergency fund, and generates retirement income. Owning property can contribute to equity and homeownership, and it allows you to hedge against inflation. Additionally, it offers access to leverage and real estate appreciation, and can provide psychological and emotional value.Understanding the distinctive nature of mortgages can help individuals make informed decisions about homeownership and leverage this powerful financial tool to their advantage. UCCU is here to help you with any questions you may have. Contact our mortgage loan experts.