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Inflation Makes Mortgages An Asset; DON’T Prepay Your Mortgage

A husband and wife look at their mortgage statement online using their laptop and calculates the impact inflation has on their asset.

Dave Ramsey is a financial guru who encourages paying off all debts, including our mortgages.

Here are Ramsey’s 7 Steps for taking control of our finances.

A lot of other finance “gurus” of sorts take serious issue with Ramsey though b/c his advice only works in a world with minimal or falling inflation – a world we’ve been in since 1981.

Ramsey loves the broader stock market for example, but it has been continually “aided” or “inflated” by Fed policy since the 1980s, so if and when the Fed changes course or if and when we experience high inflation rates, we could easily see a 1970s-style pull back when stocks fell by over 40% and didn’t recover for 10 years.

Ramsey’s advice to pay off our mortgages also comes under frequent criticism b/c hefty inflation rates seem all but inevitable now at some point.

Some of the self-styled “gurus” who disagree with Ramsey include Ken McElroy, and George Gammon and Jason Hartman, who were both in this recent Rebel Capitalist Podcast on YouTube.

INFLATION – HUGE BOON FOR BORROWERS

Long story short: When inflation is looming, a 30-year fixed-rate loan can be an asset!

Inflation is horrible b/c it slows economic growth, increases the cost of living, and punishes savers b/c their savings become worth less and less.

Inflation also punishes creditors (lenders) b/c they end up getting paid back with much less valuable dollars.

Inflation, however, is a huge boon for debtors b/c they get to pay off their debts with much less valuable dollars.

Hartman’s example is a person buying a house in 1972 for the median price of $18,000 (yes, those were the days 😊).

The interest rate was about 7.3% then, and the payment for an 80% LTV mortgage was about $100 per month.

Twelve years later in 1984 after the inflation-ravaged-1970s, the dollar was worth about 40% of what it was worth in 1972.

And that same borrower’s income had increased both with inflation and with career growth, from about $300 per month to $700 per month, making the monthly mortgage payment utterly painless relative to overall income.

He points out that even if someone’s income does not increase at the rate of inflation, her income will still increase markedly and make it far easier to pay off the mortgage.

WHY IS A MORTGAGE AN ASSET?

If inflation rates exceed borrowing rates, e.g. inflation is at 5% and your interest rate is at 3%, the lender is effectively paying you 2% to borrow money.

This is a concept most people understood in the 1970s and 1980s but now few people do b/c it is so counterintuitive.

EVEN BRIGHTER FOR INVESTORS

The above analysis is for owner-occupied housing too.

The picture is even brighter for investors, as they will not only get to pay off their mortgages with less valuable dollars, but they will get to enjoy rising rents that come with inflation – making it even easier to pay off their mortgages.

Hartman is so convinced of this benefit that he encourages homeowners to borrow as much as possible at low fixed rates, even if they have to go back to the well and do cash out refinances.

HARTMAN IS BULLISH ON HOUSING

Lastly, Hartman is very bullish on housing too b/c he thinks all of the low-rate financing taking place now will encourage borrowers to cling to their properties in a post-inflation world b/c they will not want to give up their very low rate mortgages.

As a result, inventories will be even tighter.

CONCLUSION

So, not only is housing a great inflation hedge as a “hard asset,” but a low 30-year fixed-rate makes financed housing an even better inflation hedge.

A fixed mortgage payment in a world of rising inflation, rising incomes, rising rents and a falling dollar could be the best asset we have.