Why do financial advisers seem to constantly advise people to stay in debt?
Recently Adam Hatter wrote a story on Yahoo! Finance detailing how he and his wife paid off a 30 year mortgage in less than 5 years, saving themselves, easily, over a hundred thousand dollars in interest. They went to some of the extremes that are needed to free up income in order to do this, but they are easily much wealthier as a result.
So why has Business Insider writer Mandi Woodruff basically lambasted them for doing this? It comes down to what Hatter did to free up the income they needed to pay off their mortgage: reduced retirement account contributions and suspended contributions to their children’s 529 college fund.
Mandi quoted Greg McBride of Bankrate.com, who said:
They need to be maximizing their financial responsibility by padding their emergency savings, utilizing tax favored retirement options and not pouring every spare nickle into their home, which is an illiquid asset.
Actually the fact that a home is an illiquid asset is the reason to not have any debt against it and to pay off any debt secured by it as quickly as is feasible. Viscous assets, such as real estate, are difficult to convert to cash. This means that if you suddenly find yourself without income, you’ve got a viscous asset against which you owe a ton of money weighing you down.
It seems the fact they suspended contributions to their investment accounts is really the thing killing these financial advisors. Again quoting Greg McBride:
That extra money applied to the mortgage is effectively gone until they sell the house and whether you’re selling or staying there, it’s not a free house once you get the loan paid off. You still have property taxes, maintenance and upkeep, not to mention you’ve really compromised your financial security in the meantime.
Again, that is the biggest reason to get your mortgage paid off quickly. They now have the extra discretionary income to handle issues should they arise. And they are also now far wealthier than most Americans, even those with retirement accounts. I’m likely far wealthier than many of my peers because my wife and I have been doing our best the last 4 years to shed as much of our debt as we can. And if we were to buy a house, we’d likely be paying that mortgage off as quickly as we could, too.
Given what has occurred in the mortgage markets, one word has scared people into paying their mortgages quickly: foreclosure. You see, it doesn’t matter how much you’ve been contributing to retirement and college savings accounts instead of diverting to your mortgage if you lose your income and the bank seizes your home. This is the one thing Ms Woodruff and Mr McBride continually ignore through the entirety of the article.
It may be 10, 20, 30 years for them to realize that, when their kids go to college and they haven’t accumulated enough savings and they have to borrow student loans. And yeah, they don’t have a mortgage, but they sure won’t have as much saved in retirement as they would have liked.
Their overall savings might be lesser because they suspended investment contributions over the course of the 5 years they paid off their mortgage, but, again, they now have the money to shore up their retirement accounts while potentially pursuing other investment opportunities that could have a greater return. They are wealthier now than they were when they bought the house, and they are able to take their now much larger discretionary incomes and try to generate additional wealth with it.
If your mortgage is underwater – meaning you owe more than the estimated market value of your home – then you must accelerate payments against your mortgage. This means making sacrifices. This means eating out less, cutting back on other luxuries, cutting back on retirement contributions, and directing all that extra cash to your mortgage and debts. But even if you’re not, the power of interest calculations means that the sooner you throw any extra money at your mortgage, the better. You needn’t pay it off as quickly as the Hatters did, but I see no reason to not do that either.
One other thing I’m also finding rather intriguing about Woodruff’s and McBride’s points of view is this: they presume investment accounts will only accumulate in value. One need look to only 2008, just 5 years ago, to see just how stupid banking on such an idea can really be. And there are other examples preceding even just that.
All of the events over the last 5 years in the various financial markets have scared people into shedding debt by the truckload. The old advice of keeping debt around while directing extra discretionary money toward investments just doesn’t hold water anymore. Few take it seriously anymore. It might look good on a spreadsheet, but investments are gambles, just as the future is also a gamble.
But the Hatters no longer have to worry about their home being foreclosed because they own it free and clear. Yes there are still property taxes they have to worry about, along with upkeep, but anyone who owns their car knows about these as well. Yes they lose the benefit of the potential of compound interest on investment accounts, but there are a lot of variables involved in the rosy picture Business Insider is attempting to paint, and it’s a gamble few are willing to make.
Plus there’s one other thing Business Insider seems to be overlooking: the hundreds of thousands of dollars they saved by paying off their mortgage early means that they will come out far ahead if they do sell their home than if they maintained their mortgage for nearly the entire term.
But the one thing that must always be kept in mind is this: being in debt means someone else owns a piece of your future. Getting out of debt is the only way to be in complete control of your financial future, even if you gamble a bit with investments.
And how any financial adviser could actually advocate staying in debt and risking additional money on something not guaranteed to provide a return is beyond me.
And before I close this out, a quick note about the college savings accounts: why are people so brainwashed into thinking they must pay for their children to go to college? Studies show that students who pay for their own education do better in the end. As such it’s better to have your children pay their own way through school, even if it means taking on student loans, as they are much more likely to take their education more seriously, meaning they’re more likely to come out ahead in the long run.
