To fully understand why a mortgage is considered good debt, you need to understand the differences between good debt and bad debt. Then, you can more fully appreciate why financing your home and going into debt may work in your favor in this unique instance.
Good Debt vs. Bad Debt
Good debt means you’ve taken on an obligation to buy something that will likely appreciate over time. But taking on debt for something that will lose value over time is considered bad debt.
That means financing a home mortgage is good debt. Buying a television, car, or furniture on credit cards is bad debt. There are thousands of examples, and you will incur both types of debt as you go about your life.
Consider this. If you buy a car with a 10% down payment on a 72-month loan, the total cost of that car, including financing, will run you thousands of dollars above the purchase price. But after owning that car for four years, its value might fall to half that amount or thereabouts, depending on several factors, such as how many miles you’ve driven or the amount of wear and tear on the vehicle.
And you’ll still have two more years left to pay off the loan you took out for it.
Alternatively, mortgages are one of the best examples of good debt. Real estate is proven to appreciate over time, and while this is not guaranteed, it makes even more “good debt” sense when compared to the prospect of renting an apartment, which has no appreciation value at all.
You’re simply throwing money away month after month.
The Upsides of Mortgage Debt
Mortgages defy the traditional logic that all debt is bad. Mortgages are an investment in your financially independent future, adding value much like stocks, bonds, or similar investments typically provide in the long run.
Here are some reasons why mortgage debt differs from most other forms of debt.
Low Interest Rates
Mortgages are one of the least risky loans that lenders offer because they are secured by the property you buy. If you ever run into problems paying your mortgage, the lender can foreclose and recoup their investment.
Home loans are secured debt vs. credit cards, which are unsecured debt, and why the latter has interest rates 3x-4x those of home loans.
Preferential Tax Treatment
The interest you pay on your mortgage is generally tax-deductible, which is not true for other kinds of debt. The government understands that strong communities start with home ownership, which is why it offers tax breaks to those who make a big financial commitment that brings stability and the pride of homeownership to a neighborhood.
Protects Against Financial Emergencies
As your home builds value, you may be able to tap into that equity if a major financial setback occurs. It could be a health issue, job loss, divorce, or other significant impact. Taking out a home equity loan to cover those expenses means that the catastrophic nature you’re dealing with can be minimized to a great extent.
An Improved Credit Score
Counter to most other types of debt, the value of your home secures a home mortgage, and as a result, lenders interpret this as being responsible credit use. You’re rewarded with a higher credit score as a sign of financial stability when you make payments on time and build a solid payment history.
Protection Against Volatility
This applies mainly to fixed-rate mortgages. Knowing precisely what your mortgage payment is each month can create more financial stability in your life. When inflation accelerates, your payment stays the same. You’re also protected if interest rates rise significantly.
It gets even better when interest rates drop below the rate you’re currently at because you may be able to refinance and get an even better deal than you had before.
A Potential Source of Retirement Income
Homeownership can also serve as a source of retirement income. Reverse mortgages are growing in popularity among retirees who are taking out this type of loan in which the lender pays you a set amount every month.
You still get to live in the home and get a regular income stream in retirement without selling your home.
The Emotional Benefit of Home Ownership
This isn’t a financial benefit in the strictest sense, but you should also consider the psychological benefits of owning a home. There is value in peace of mind, stability, and fulfilling your role as a provider for your family when you buy a home.
Owning a home allows you to establish roots and create a living space that reflects your personal style by making improvements and changes that are unique to you. It’s difficult to put a price on this, but don’t deny this unquantifiable benefit.
» MORE: See today’s refinance rates
A Final Thought
Mortgage debt is tied to a tangible appreciating asset, making it good debt vs. unsecured loans on depreciating assets considered bad debt. Of course, there is risk associated with any kind of debt, but a home mortgage minimizes this uncertainty and can work well in your favor when you make payments on time and allow your most significant asset to appreciate over time.