Should you carry debt in today’s economy?

by Tom Tousignant

in Blog, Mortgages, Wealth Building

I’ve been saying for years – Mortgage debt along with other savings is far better than no debt with no savings. In other words, build up your savings and form the habit of saving money, then pay off your mortgage.  apparently, the Wall Street Journal thinks so also:


It would be the height of foolishness to load up on debt now, right?

Just look at the news these days. Homeowners are being foreclosed on at a record clip. Governments around the world are lurching toward insolvency. Job growth in the U.S. remains feeble at best. And at the center of the global economic storm are bad loans, which promise to weigh on consumers, businesses and governments for years if not decades to come.

And yet—and yet!—the cold clarity of financial analysis points to an inescapable conclusion: There has never been a better time for people to borrow money, whether to buy financial assets or boost cash reserves.

Alan Greenspan, Chairman of the Board of Gover...
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For sophisticated, disciplined investors who have lived and invested within their means—and perhaps decried the bailouts being lavished on those who haven’t—this is your time to take advantage. Not only are interest rates just about as low as they can get, but future inflation could erode the paper value of loans, making debt even cheaper over the long run.The first step involves making peace with the idea of taking on new debt at this perilous moment in global economic history.

It isn’t an easy concept to embrace. While the inflation scenario seems likely over the long term, there is a small but growing chance that the global economy could suffer from the opposite problem, deflation. Japan could be the template for the kinds of problems facing the U.S. and other advanced economies: years of tepid growth and falling asset values and prices.

That would make new debt more expensive over time, not less so. It would also mean that the job market is headed for a longer slump than even the direst estimates now suggest.

Then again, the moments that seem the bleakest often turn out to be inflection points. Alan Greenspan has famously said that the worst of loans are made at the best of times. The opposite holds true as well.

Most important, “there’s nothing inherently wrong with leverage,” or borrowed money, says Christopher Jones, a New York financial planner working with high-net-worth clients. For people with the capacity to take on debt, who understand it and can tolerate the risk, “now is an ideal time to leverage cheap dollars to buy into areas that can produce much higher returns over the longer term,” he says.

Mr. Jones is advising clients who can afford to pay cash for a home to take out a mortgage instead and invest the funds in a diversified portfolio. “If you look at where the market is now and where it could be five to 10 years from now, the return potential is significant,” he says. Ideally, investors would want to borrow at rates below 5% and invest the money in a well-diversified portfolio aiming to return 8% a year over 10 to 15 years.

“You don’t want to be borrowing money and going to Vegas with it,” Mr. Jones says.

Investing the Proceeds

Wealthier investors who already have built up considerable equity in their homes might even consider—gasp—a cash-out refinance. Yes, this sort of behavior is what got so many people in trouble during the housing bubble. And, yes, leveraging a home to the hilt can be dangerous because if home prices continue to slide, you could owe more on the house than it is worth.

But people who have a potentially profitable use for that money—preferably an investment—could come out ahead using this strategy. A borrower who takes out a mortgage at 4.5% is essentially borrowing money for free on an after-tax, after-inflation basis, assuming he or she is in the 33% marginal tax bracket and inflation returns to its long-term average 3% or more, says Greg McBride, a senior financial analyst at “That’s probably the best example of how those who are well positioned can utilize the low-rate environment and leverage up their financial return prospects,” he says.

If that hypothetical investor were to take out a $400,000 loan at 4.5%, he would come out ahead if his portfolio makes more than 3.015% a year after taxes, says Terry Siman, a wealth adviser in Spring House, Pa. If you assume 2% a year is lost to taxes, such as capital gains, dividends and interest income, then the portfolio needs to return 5.015% annually to break even. “Anything better than that and you’re in a winning situation,” says Mr. Siman.

Skip Fiore is a Waretown, N.J., director of a digital print-manufacturing company nearing retirement who is looking to rebuild a nest egg devastated by the stock-market collapse. He has no mortgage on his $1 million home, so he is in the process of taking out a $300,000 mortgage at a fixed rate of 4.75%, and plans to use the money to invest in his portfolio. “Fundamentally, it was cheap money,” he says. “And it was cheap money that could be used to supplement a depressed retirement portfolio.”

The risk, of course, is that the investment returns will be lower than the new mortgage interest rate. Investing in bonds probably wouldn’t make sense, says Mr. Jones, the financial planner, because Treasurys or high-quality corporate bonds aren’t yielding enough to offset the cost of carrying the debt.

Also, investors who are borrowing against their home can’t invest the money in municipal bonds and get both an interest-tax deduction for the home-equity loan and the tax-free income from the municipal bonds. “There’s no double dipping,” says Mr. Siman, who is working with Mr. Fiore to rebuild his nest egg.

Mr. Jones suggests using home-equity money only in a well-diversified equity portfolio split among U.S. and international markets.

Within the U.S. portion, he suggests buying equal amounts of U.S. large growth, U.S. large value, U.S. small growth and U.S. small-value and real-estate investment trusts. On the international side, he suggests equal helpings of large growth, large value, small growth, small value and emerging markets.

Marc Schindler, a certified financial planner in Bellaire, Texas, is encouraging clients to consider “pulling equity from their home with the idea they can invest and generate better returns.”

Rate of return is a big key when looking at leverage vs. mortgage payments.  Also consider the advantage of Liquidity and the Safety of Principle in your Mortgage Plan.

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