I receive a fair number of videos, emails and articles about the coming financial crash. It is always nigh. It is always imminent. And the advice on how to prepare for such a cataclysmic event almost always involves paying off your mortgage
TEOTWAWKI is survivalist shorthand for “The End Of The World As We Know It.”
What exactly will bring on TEOTWAWKI isn’t always clear – Reaching the debt ceiling, taxes increasing, Atlas shrugging, the Zombies Apocalypsing – but what is always part of the advice is to make sure that you own your own home outright. The threat for unpreparedness is the claim that if the bank or the federal reserve owns your home they will come and get it and you will be homeless.
In this our fourth in the end-of-the-world-countdown series we critique the advice:
4. Pay off your home mortgage.
Most of the TEOTWAWKI scenarios begin with the claim that the Federal Reserve is printing money like there is no tomorrow. The Fed is doing this in order to devalue the dollar so that they can pay off the national debt with a devalued currency. So far the critique is correct, but what does this mean regarding whether or not you have a mortgage?
If the Fed is increasing the money supply then they are devaluing the purchasing power of the US dollar. This should cause inflation even if official measurements of inflation are artificially low.
So you have a choice:
(a) Pay off your mortgage with valuable dollars today which still have significant purchasing power.
(b) Pay off your mortgage with cheaper and easier to get devalued dollars over the next 30 years.
Why would you want to use valuable dollars today when you can use cheaper dollars over the next three decades?
If we really have Zimbabwe-type inflation we will all be carrying Trillion dollar bills just to pay for lunch. And you will be able to pay off your mortgage with pocket change.
In fact, the best hedge against inflation is a 30-year fixed mortgage. Especially at the 3.625% rates many of us have refinanced at.
Think about it another way: A $300,000 30-year fixed mortgage has payments of $1,368.15. Over the course of 360 payments, the mortgage will cost $492,534. Paying cash for your house will save you $192,534. But it will cost you $300,000 that you could have invested in the markets.
At at 10% rate of return, your investments should double about every 7 years. At at a 7% rate of return they should double about every 10 years. Equity returns have averaged about 6.5% above inflation. Inflation has averaged about 4.5%. This is why people say that equity returns have averaged 10-12%. The higher inflation is the higher the expected return for equities. But for this purpose, let’s assume that equities only average 7% and therefore only double every 10 years.
If you pay off your mortgage with $300,000 you will save $192,534 in interest over the course of 30 years. If you invest $300,000 in equities they might double every 10 years.
If your investments double every 10 years then over the course of 30 years your investments should go from $300,000 to $600,000 to $1.2 million to $2.4 million.
So you can save $192,534 but only by forgoing the possibility of $1.9 million in growth.
So long as interest rates are at historic lows, the wealthy are leveraging their homes and buying as much real property (real estate) as they can and getting the longest fixed rate of interest they can.
Not only do most of us have an interest rate under 4.00%, but since interest payments are tax deductible, the government is paying 1-2% of that interest for us in the form of a tax deduction.
Given my choice of owning my home outright and owning an equivalent value of publicly traded companies as well as my home so long as I make low fixed interest rate payments, I would much rather own both. Gains on the global stock portfolio should more than outpace the fixed low interest payments.
For more detailed information read our series of article on “Using A Mortgage Wisely“.
Remember, an investment is something which pays you money. Obviously if you are the type of person who would spend the equity in their house on something which isn’t an investment then you are better off paying off your mortgage. You have to have financial discipline in order to purchase investments.
Let me address one final argument given as to why you should pay off your mortgage. It is suggested that if we really have TEOTWAWKI in the United States it would be better to own your own home. But consider the lessons of history. When those persecuted in Germany faced their own TEOTWAWKI was it better for them to have all of their net worth bound up in the ownership of their own homes? Or was it better for them to have global assets which you could take with you to another country.
If you are really worried about the end of the world as we know it, better to have investments in many countries. Better to have a home with a mortgage which you can just abandon and leave behind. Whether or not the world is ending, it is better to have a 30-year fixed mortgage at these historically low rates.
4. Keep a 30-year fixed mortgage at these historically low rates as a hedge against inflation.
Photo by Owen Blacker used here under Flickr Creative Commons.
See also all the articles in the How To Prepare For The “Coming Financial Apocalypse” series.