An Experiment in Scotch

I recently started receiv­ing Kiplinger’s mag­a­zine, a Christ­mas gift from my dad. I was work­ing through the first issue I received when on page 9, I ran into an arti­cle of such glar­ingly bad advice that I almost thought it was par­ody. Thank­fully, though Kiplinger’s is foment­ing stale finan­cial advice on their read­ers, they have joined the 21st cen­tury and put their con­tent online so here’s the arti­cle for your perusal as we go along. The arti­cle argues that peo­ple who choose 15 year mort­gages over 30 year mort­gages or who pre­pay their prin­ci­pal down through­out the mort­gage are mak­ing a big finan­cial mistake.

Right off the bat, an astute reader can see where this is going:

When it comes to home loans, we’re a nation of debt-a-phobes.

This is in fact not true. Home­own­er­ship rates are actu­ally higher than they were 40 years ago but the equity in the homes have steadily fallen since World War II. That actu­ally means we, the cit­i­zens of the US, are the oppo­site of debt-a-phobes. While it’s true that the last few years have seen a huge delever­ag­ing in the con­sumer sec­tor, it’s akin to com­ing down to base camp on Mt. Ever­est from the sum­mit. While the height has changed dra­mat­i­cally, we’re still badly in debt. The aver­age con­sumer is delever­ag­ing because of poor eco­nomic out­looks after years of being told that con­sump­tion was the path to the holy land of hap­pi­ness. This is com­pletely ratio­nal behav­ior and yet, Kiplinger’s, in all their infi­nite wis­dom, is now argu­ing that not only should you own a home, you should buy it with a 30 year mort­gage instead of a 15 year mort­gage and that you should never pay down the principal.

They argue that the 30 year loan con­fers tax advan­tages on the owner (true) and that by lever­ag­ing that advan­tage, your effec­tive mort­gage rate is 2.9%. They then make the amaz­ing leap of con­clu­sion that there is a good chance you can make more than that in the stock and bond mar­ket over the long term, con­ve­niently leav­ing off the nec­es­sary qual­i­fier for what “long-term” means in this sce­nario. Based on the last 10–15 years of the stock mar­ket per­for­mance, it seems safe to think “long-term” might be much much longer than what the aver­age Kiplinger’s reader might feel com­fort­able with.

The next whop­per is this:

You can save a lot of inter­est by choos­ing a 15-year loan over a 30-year — about $63,000 after taxes on a $200,000 loan for some­one in the 28% tax bracket. But ask your­self whether you can really afford the higher monthly pay­ment — in this case, $1,420 ver­sus $955. Have you maxed out your 401(k) and built up an emer­gency fund? Paid off credit cards? Funded insur­ance poli­cies and, if you desire, col­lege sav­ings? If you haven’t, choose the 30-year loan. And if you have, choose the 30-year loan any­way and put the dif­fer­ence between the two pay­ments in a sav­ings or invest­ment account.

There are so many prob­lems with this para­graph it’s hard to know where to start. First of all, this is akin to argu­ing that you should buy a TV with a credit card instead of cash if you can’t afford the TV. Here’s a bit of advice: if you can’t afford the 15 year pay­ment, you’re buy­ing too much damn house. The author just hand­waves away that $63,000 in inter­est as if it’s mean­ing­less in terms of your finan­cial free­dom when in fact it’s a HUGE issue for why peo­ple stay in debt. Then after try­ing to dis­miss the inter­est, she says to do it even if you can afford the 15 year and use the dif­fer­ence to fund other sav­ings, ignor­ing the fact that if buy­ers don’t have the dis­ci­pline to pay for a 15 year mort­gage, they prob­a­bly don’t have the dis­ci­pline to pay for a 30 year and use the dif­fer­ence to fund other sav­ings. Again, if you haven’t funded your sav­ings and if you have sub­stan­tial credit card debt, you shouldn’t be buy­ing a house to begin with, much less a house with a 30 year mort­gage that will cost you $63,000 over the course of the loan. This is fun­da­men­tal finan­cial advice that we the Amer­i­can con­sumer have ignored for 30 years to our own peril.

The logic gets even more twisted:

There are few bet­ter hedges against infla­tion than a mort­gage. If infla­tion rises, so will inter­est rates. But you’ll have bor­rowed at a low, fixed rate while sav­ings rates climb and you’ll pay the loan back with increas­ingly cheaper dollars.

If this is true (which it is in a way), it’s even more true with a 15 year mort­gage since the rates on 15 year mort­gages are EVEN LOWER than 30 year mort­gages. So this lit­tle gem actu­ally proves the counterpoint.

Over­all, the entire advice is based on the now hor­ri­fy­ingly bro­ken assump­tion that home prices will rise over time. While this was true for the first part of the rush to own a home in Amer­ica, there is lit­tle evi­dence that it is now, or will become, true. The hous­ing boom was dri­ven by a cycle of extremely easy money pro­vided by a lax Fed­eral Reserve who refused to believe that a bub­ble was blow­ing up right in front of their eyes. The glut of homes in fore­clo­sure will con­tinue to sur­press prices and the excep­tion­ally gloomy eco­nomic out­look will keep the hous­ing mar­ket from any kind of rebound for the fore­see­able future. Telling peo­ple to lock them­selves into a 30 year debt that may very well be worth less money when they sell it is like telling peo­ple they should buy a car with a 6 year loan.

Debt is not a bad thing, in and of itself if you are dis­ci­plined and if you have a way to lever­age that debt to your advan­tage. How­ever, the days are long gone of buy­ing a house and watch­ing the price go up, essen­tially becom­ing a built in sav­ings account. Debt has to be used intel­li­gently and infre­quently by con­sumers and there is no evi­dence most con­sumers are capa­ble of the dis­ci­pline required. See­ing this kind of advice in a major finan­cial out­let just shows we have an excep­tion­ally long time yet to go before the eco­nomic pic­ture becomes any­thing resem­bling rosy.