Most of don’t have enough cash in the bank to pay in full for our home, especially a first home. With interest rates historically low, we’re consistently hearing questions about real estate and debt. How much should I put down? Should I pay-off my house? Should I refinance to a longer term? All valid questions with the answers more than figuring dollars and cents. Here are two prevailing approaches to debt in real estate: 

Good Debt v. Bad Debt

This approach to debt makes a distinction between consumer and investment debt. Roughly, consumer debt is anything we purchase that depreciates in value over time. Some examples are cars, boats, ATVs, even our clothes (You can make payments on those now!) or anything we put on a credit card and don’t pay for in the next month. On the other hand, good debt is used to purchase assets that appreciate or produce income. These assets could be your home, rental property, land, livestock, or equipment used in a business. Someone who utilizes good debt often utilizes the leverage to invest in more assets. For example, someone purchasing a home has $50,000 in cash. Instead of using the entire $50,000 to purchase the asset, he or she will use a portion of it for a down payment, obtain a loan for the balance, and use the rest to purchase another asset. Two negative aspects of using good debt are that a person becomes accustomed to using debt, so we might be more likely to use it to falsely increase our lifestyle instead of appreciating assets. Second, most proponents of good debt claim paying Private Mortgage Insurance (PMI) by paying less than 20% down negates the positive impact of leveraging property.

Minimal Debt & Pay It Off

We know very few people who don’t know the Dave Ramsey approach to debt: You should have none! Yes, a debt free life does give most people a peace of mind that an emergency or sudden life change will allow a person to continue holding their home or other real estate. However, paying off real estate sometimes doesn’t make financial sense. The tax deduction changes in the past few years make interest deductions, which CPAs often cited as a reason to not pay off your mortgage, a limited advantage for most of us. On top of that change, interest rates are at all-time lows. Many experts are advising that they will rise in the next 5 years, and property owners can hedge against those increases by locking in long term loans.

Your next question is this, “Which approach should I use?” We can’t give you that answer because it lies in your own personal goals. lifestyle, and situation. We might use different approaches at different times in our life. Buying your first home? Most of us are cash poor at that point, so good debt might be the smartest bet. Two or three years from paying off your mortgage with a high interest rate? Paying it off might be the best option instead of refinancing when you calculate the costs. Empty nesters concerned about the impact of the lower interest rates on the cash in the bank could use good debt to purchase an asset with a higher return. Looking toward retirement and concerned about expenses? Those people might look at paying off their mortgage while they are still working to control expenses later. With everything we do, our advice is always to keep your approach to debt simple and make your own plan to fit your needs. When you need advice, contact a trusted expert to help you guide you.

--William & Alison