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2 Reasons Piling On Mortgage Debt May Be a Bad Idea

By Nathan Hamilton - Mar 1, 2017 at 6:21PM

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You may not want to risk taking on mortgage debt in these scenarios.

A piggy bank with glasses, standing next to a chalkboard, with the word "spend" crossed out and "save" written at the bottom.

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The reality for most Americans is that buying a home means taking on a pile of debt. Current mortgage rates are still at multi-decade lows and financing costs are historically low, allowing homeowners to take on less debt, compared with recent decades, for the same value home or refinance to save money each month.

But it's difficult enough to save for a small down payment, let alone the full cost of a home, and the only other option is tapping lenders to borrow money. With that in mind, Motley Fool analysts Kristine Harjes and Nathan Hamilton discuss in the following video two cases when piling on mortgage debt may be a bad idea. Whether it's overshooting what your budget can handle when getting pre-approved for a mortgage or viewing your home as purely an investment, these two factors could affect your wealth. Listen in to learn more.

Kristine Harjes: Owning a home can often feel like it's part of the American dream, and so many people do eventually buy their own homes, often through a mortgage. But, you need to be very careful. There are two reasons why piling on mortgage debt to buy a home is actually a bad idea.

Nathan Hamilton: And I'm glad you said part of the American dream, because there's this belief that everyone should be able to afford a home when, in reality, if you look at it, regardless of political opinion, sometimes the economics don't work out. And one thing -- maybe this is just my personal opinion on it -- is mortgage is debt, and not everyone looks at it as debt where some people think debt's a bad thing. They'll say, "OK, I'm going to get a mortgage to buy a home because it's my right and part of the American dream."

Harjes: And it's understandable to think, "OK, mortgage debt. That's different than credit card debt." It is, but it's still debt.

Hamilton: It is still debt. It can be dangerous. It is lower interest rate debt than credit cards, but it can be dangerous if you're not budgeting correctly. So when mortgage debt is not a good idea is, one, essentially it's your single, largest monthly expense. If you look on average, renters pay about 25% of their gross income for rent, but mortgage lenders will lend you up to 43%. That's a huge jump, and if you look at your actual budget financials, my guess, and if you look at the numbers and so forth, most Americans can't afford 43% debt to income for a mortgage payment.

Harjes: Especially when you consider all of the additional costs that are incurred when you own a home.

Hamilton: Absolutely. On average, new homeowners will spend $13,000 on renovations, furniture, what have you.

Harjes: Right. And another important caveat to this is that there's an opportunity cost associated with putting that money into your mortgage payment month after month. You could, for example, be investing that in the stock market and hope to get an 8%-10% return.

Hamilton: And that's the second point that you mentioned. Houses have been looked at as investment vehicles, and they're not necessarily investment vehicles. Some people have made money, granted. Different real estate developers might use highly leveraged debt to get there. But over the very long term, adjusted for inflation, if you look at the return of the housing market, it's actually pretty dismal compared to what you can get in the stock market.

Getting a house isn't a bad idea. I fully believe in the American dream, owning a home and so forth. It is the place you build your family. But I wouldn't necessarily look at it as an investment. Don't think about it as, "OK, I've got my home. I'm going to leverage myself with debt because there's a good return there." There may or may not be in the very short term, but over the long term, the trends just don't suggest that and there may be better uses for that money, as you mentioned. An opportunity cost.

Harjes: So it's important to realize that for most people, a home is a consumption vehicle.

Hamilton: It is, absolutely.

Harjes: It's necessary. You need shelter. But the difference in thinking about it is as something that you are going to invest in, in the sense that you're purchasing it and it's something you'll have for the long term, versus a vehicle you can put money into and expect it to appreciate a bunch.

Hamilton: Yes, an investment not by definition, but by actual execution is not a consumption sort of thing. You don't keep on putting money into it and not receive it back. You put money into it and you get more money in the future, hopefully if everything works out as intended, but houses really are a consumption vehicle. They take money out of your account and, if not managing it in a very smart way or within your budget, it can have some dangerous impacts.

Harjes: Exactly. So to sum up, owning a home is a wonderful thing. Most Americans will, at some point, and many people do that with mortgages, but there are times in which it might be a bad idea.

If you're looking for more information on mortgages, go to where you can compare rates and get in contact with certified lenders, or even download our free mortgage guide, "5 Tips to Increase Your Credit Score Over 800."

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