I recently started receiving Kiplinger’s magazine, a Christmas gift from my dad. I was working through the first issue I received when on page 9, I ran into an article of such glaringly bad advice that I almost thought it was parody. Thankfully, though Kiplinger’s is fomenting stale financial advice on their readers, they have joined the 21st century and put their content online so here’s the article for your perusal as we go along. The article argues that people who choose 15 year mortgages over 30 year mortgages or who prepay their principal down throughout the mortgage are making a big financial mistake.
Right off the bat, an astute reader can see where this is going:
When it comes to home loans, we’re a nation of debt-a-phobes.
This is in fact not true. Homeownership rates are actually higher than they were 40 years ago but the equity in the homes have steadily fallen since World War II. That actually means we, the citizens of the US, are the opposite of debt-a-phobes. While it’s true that the last few years have seen a huge deleveraging in the consumer sector, it’s akin to coming down to base camp on Mt. Everest from the summit. While the height has changed dramatically, we’re still badly in debt. The average consumer is deleveraging because of poor economic outlooks after years of being told that consumption was the path to the holy land of happiness. This is completely rational behavior and yet, Kiplinger’s, in all their infinite wisdom, is now arguing that not only should you own a home, you should buy it with a 30 year mortgage instead of a 15 year mortgage and that you should never pay down the principal.
They argue that the 30 year loan confers tax advantages on the owner (true) and that by leveraging that advantage, your effective mortgage rate is 2.9%. They then make the amazing leap of conclusion that there is a good chance you can make more than that in the stock and bond market over the long term, conveniently leaving off the necessary qualifier for what “long-term” means in this scenario. Based on the last 10-15 years of the stock market performance, it seems safe to think “long-term” might be much much longer than what the average Kiplinger’s reader might feel comfortable with.
The next whopper is this:
You can save a lot of interest by choosing a 15-year loan over a 30-year — about $63,000 after taxes on a $200,000 loan for someone in the 28% tax bracket. But ask yourself whether you can really afford the higher monthly payment — in this case, $1,420 versus $955. Have you maxed out your 401(k) and built up an emergency fund? Paid off credit cards? Funded insurance policies and, if you desire, college savings? If you haven’t, choose the 30-year loan. And if you have, choose the 30-year loan anyway and put the difference between the two payments in a savings or investment account.
There are so many problems with this paragraph it’s hard to know where to start. First of all, this is akin to arguing that you should buy a TV with a credit card instead of cash if you can’t afford the TV. Here’s a bit of advice: if you can’t afford the 15 year payment, you’re buying too much damn house. The author just handwaves away that $63,000 in interest as if it’s meaningless in terms of your financial freedom when in fact it’s a HUGE issue for why people stay in debt. Then after trying to dismiss the interest, she says to do it even if you can afford the 15 year and use the difference to fund other savings, ignoring the fact that if buyers don’t have the discipline to pay for a 15 year mortgage, they probably don’t have the discipline to pay for a 30 year and use the difference to fund other savings. Again, if you haven’t funded your savings and if you have substantial credit card debt, you shouldn’t be buying a house to begin with, much less a house with a 30 year mortgage that will cost you $63,000 over the course of the loan. This is fundamental financial advice that we the American consumer have ignored for 30 years to our own peril.
The logic gets even more twisted:
There are few better hedges against inflation than a mortgage. If inflation rises, so will interest rates. But you’ll have borrowed at a low, fixed rate while savings rates climb and you’ll pay the loan back with increasingly cheaper dollars.
If this is true (which it is in a way), it’s even more true with a 15 year mortgage since the rates on 15 year mortgages are EVEN LOWER than 30 year mortgages. So this little gem actually proves the counterpoint.
Overall, the entire advice is based on the now horrifyingly broken assumption that home prices will rise over time. While this was true for the first part of the rush to own a home in America, there is little evidence that it is now, or will become, true. The housing boom was driven by a cycle of extremely easy money provided by a lax Federal Reserve who refused to believe that a bubble was blowing up right in front of their eyes. The glut of homes in foreclosure will continue to surpress prices and the exceptionally gloomy economic outlook will keep the housing market from any kind of rebound for the foreseeable future. Telling people to lock themselves into a 30 year debt that may very well be worth less money when they sell it is like telling people they should buy a car with a 6 year loan.
Debt is not a bad thing, in and of itself if you are disciplined and if you have a way to leverage that debt to your advantage. However, the days are long gone of buying a house and watching the price go up, essentially becoming a built in savings account. Debt has to be used intelligently and infrequently by consumers and there is no evidence most consumers are capable of the discipline required. Seeing this kind of advice in a major financial outlet just shows we have an exceptionally long time yet to go before the economic picture becomes anything resembling rosy.