Burn the Mortgage

Back before subprime loans and the mortgage meltdown...before MBS and CDOs...there was a time when people actually set a goal of paying of their mortgage and then burned the note in celebratory fashion. The mindset was that debt was bad and getting the home paid off was a great success.

In the last 2 decades a parade of experts have created lots of reasons not to pay off the mortgage. First, rates were cheap. You'd have to be silly not to borrow at 6% if the S&P 500 returned 10%. Second, mortgage interest is tax deductible. The after tax cost of borrowing is even lower than the note rate. And it feels good to take that fat income tax deduction. Third, carrying debt into retirement is no big deal since you can always work and your investment income will be more than adequate anyway.

The mortgage industry, from street level brokers to Wall Street analysts and DC lobbyists, embraced the idea that not only should Americans carry a mortgage, they should refinance to get a lower rate, take out equity for consumption or even lengthen the term to reduce payments.

Maybe its time for consumers to turn their backs on the mortgage. Here are a few reasons.

(1) Paying off the mortgage is like insurance. Yes, you could in theory work or cash in investments to meet payment obligations, but what if you cannot work and/or your assets are depreciated? Paying off the mortgage protects you from getting trapped. In effect the house pays your rent for you no matter your situation once you pay off that note. Plus if you put more equity in going "under water" is less of a problem.

(2) The tax benefits are not as great as you may think. Interest is a sizable portion of the payment for the first few years and then starts to decline faster over the term of the loan. The property tax deduction remains a significant value even if interest is no longer paid. Several economists have shown eliminating the mortgage interest deduction would have minimal effects on the market (in effect all buyers and sellers expect the deduction and prices adjust accordingly), although it would need to be carefully phased in.

(3) Paying off the mortgage creates a constraint to spending. If you have your money tied up in your house and refuse to take out home equity, you won't be lured into spending that money. Behavioral constraints are important for most consumers and this is a simple way to create one.

(4) Having a mortgage takes your time and energy...and money You have to manage the payments and deal with the lender/servicer, etc. Plus remember you are paying interest. All that is a cost you can avoid. Not to mention any anxiety related to knowing you owe another payment next month. And then refinancing incurs even more real transaction costs. And if the refi is not for a term shorter than the remaining years in the loan, it just lengthens out the time people are in debt.

Imagine a consumer movement that rose up to reject serial refinancing and worked hard to pay off every mortgage early. Think how much more stable consumers, housing, maybe even the economy might be...

But alas, its seems unlikely mortgage burning parties are going to make a comeback. What might help? End the mortgage interest deduction, at least for non-first time buyers and for all forms of home equity loans. Require loan applicants for all refinance loans that are not for a shorter term than their existing loan to attend mortgage counseling. And celebrate those who pay off their loans.

As it is about 24 million of the 75 million home owning households in the US owns their home free and clear with no mortgage. The majority are not rich either - with incomes under $50,000. At the very least they can sleep tonight knowing they are not at risk of foreclosure.