Thursday, January 3, 2008

Mortgage Debt, Financial Risk, and the Bible

Sometime last week I came across this post on mortgage debt and financial risk, then a few days ago at dinner my mother-in-law was talking about her conversation with a so-called "Crown Ministries Guru" who was evidently rather condescending to her about her desire to liquidate an investment account to pay off a (lower interest) HELOC. She argued that paying off the loan is the only biblical option; he argued that it didn't make sense. I find both of these positions interesting, but the case of the guru more than the blog poster.

With respect to the blog, John argues that he is reducing his risk by having a mortgage on his house and having that money invested somewhere else. Presumably he has it in a non-insured investment since most people with this theory seek to make greater returns on the investment than the interest on the house and you're not going to get a CD or insured bond with a better return than your mortgage interest or the banks would lose money (which banks don't like doing). So his theory is that if the market for your individual house drops you've lost tons of money on your house but he has his money better diversified. The first problem with this is that if his investment drops at the same time that he loses income he might lose his house; if the housing market is down at the same time he might even lose it at a loss. You will never lose a paid off house unless a judgement is delivered on some unrelated debt (or the government decides they can get more tax money from somebody else, but that's an unrelated issue). Trent (the author of "The Simple Dollar") argues that he is ignoring this personal risk but is correct about diversifying his financial risk. He's not. Lets say that John and Tristan both have $100,000 homes. John takes out $80,000 of that and puts it in a guaranteed bond and Tristan has the house totally paid off. Both of their houses are in markets that go in a huge slump and the house price drops to $60,000. Tristan now owns a $60,000 asset (a house). John now owns a $60,000 asset with an $80,000 lien on it plus a second $80,000 in the bond, bringing both of their net worths to $60,000. It may be true that John makes more money because his outside assets he leveraged the house to buy make more money than the interest on the mortgage, but it is never true that he has reduced his risk. The same thing goes for any investment made with other peoples' money. You can make huge money buying commodoties on margin, but you can also lose your shirt. Taking out a loan and investing it can only increase your risk because you have a loan that must be repaid and an asset that you might be able to recover. Even if it's insured you're not really guaranteed you'll collect in a timely manner.

Now we get to my mother-in-law's question. Her assertion something along the lines of that if The borrower is slave to the lender, and You cannot serve two masters and that she should Leave no debt outstanding, except the continuing debt to love one another. Then it would seem unbiblical to keep debt, certainly when you can pay it off. Proverbs certainly teaches us it is unwise to be a man who strikes hands in pledge or puts up security for debts. I've taken Crown Ministries and considered taking the class to be a teacher and I'm pretty sure that it is totally contrary to the tenets of that program to argue that if you have given a pledge to stranger you should do anything but deliver yourself like a gazelle from the hunter or a fowl from the hand of the fowler. I asked her what biblical insight he provided and she said he only said that it would be foolish to keep put money in an account that gets less interest. My only response is that the foolishness of God is wiser than men.

Having said that, I'm probably about to put money in an investment account rather than pay off my mortgage, so I'm not saying keeping your mortgage around is always a bad idea. I'm not a die hard Ramseyite. I have personally paid off my student loans, for instance, but I can see that keeping them around at 3% interest (which I know exist) and sticking the money in an FDIC insured savings account with total liquidity and 5% interest makes financial sense. I wouldn't do it because I like my finances boring, but I don't think it's a bad idea. My situation is that I know my car is going to die and I'm going to need a new roof and new siding in the next 10 years so I need to build up enough liquidity to take those hits without having to get another loan which is almost certain to be worse than my current 5% loan on the house. Thus my money will not be going to paying off the home early, it will be going to a semi-liquid fund for pending expenses. I want to escape that house debt, but I also need liquidity and a wise man plans for the future.


Chris said...

So I guess my big question for the hardcore no-debtors is why should selling your house be off the table if you feel like debt is so strongly condemned biblically? If secured debt is so terrible, there is an easy way for everyone to get out if you feel like that's God's calling. I think those people like to believe that they're Grandfathered in, buying a house with debt was a mistake I made in the past, but it's a mistake I get to live in and enjoy while I try to fix it very slowly.
To me it all comes down to two forms of risk tolerance. The tolerance of the individual and what the individual's tolerance should be given their situation (the closer you get to retirement, the smarter it is to have your house paid off regardless of how you feel about it). Personally I think the combined tax benefits of deducting mortgage interest and interest accrued from investments more then offsets the additional risk I have by not having a house fully paid off, but I'm young and own a goodish percentage of my house, so the market would have to drop 40% before it would be a problem to get out. If the numbers were different I might feel differently, but I don't really have a problem not paying my mortgage off early.

Chris said...

I guess the other thing is that I actually dispute that paying off your home early is less risky. If I were laid off tomorrow, I'd rather have 50k in a brokerage account then to have that much less debt on my house. Even if you prepay, the same mortgage payment is due every month.

Christopher said...

I actually tend to agree with that. I should have been more clear in my post that I'm not claiming that having a mortgage debt is sinful (and if I were then I would agree that I must sell my house, but instead I'm choosing to keep the debt around and invest money to gain liquidity). The Bible pretty clearly states in several places that debt in general is unwise, but following everything in Proverbs is not a command for Godly living.

But I find it insane that someone within the church would brush off her concerns about what the Bible says with a response about interest rates. You might disagree with her interpretation, but then we can have a debate about interpretation. To respond to scripture with interest rates is what I primarily took offense to in his opinion. (And her perception that he was extremely condescending to her position because of the money she would be losing.)

Christopher said...

As a matter of liquidity risk that's correct, which is why I'm not planning on prepaying just yet. Wise investment would require that you have sufficient liquid capitilization to cover things like cars dying or losing your job. Ramsey would argue 3-6 months, but given the state of my car, siding, and roof I think I need something different than a normal emergency fund.

I was speaking to the risk of losing value in the investment, which is not mitigated by taking a loan on the investment (which is what the commenter on The Simple Dollar claimed).

Chris said...

Yeah, I pretty much agree with you, I didn't interpret you to be saying debt was sinful, but I have heard that opinion expressed before by people who would never consider selling their house. That's the only point I was bringing up.

Chris said...

Oh, and I 100% agree with you that prepayment or lack there of is not a hedge against fluctuations in the housing market. I think you nailed that one.