Home Mortgages in a Low-Inflation Era

Times Staff Writer

Question: Several years ago I used to hear that it was not a good idea to own a home with a fully paid mortgage. I don't recall if I ever heard the reasoning behind this, but have been wondering recently if that thinking was right and if it's right now.

Our 30-year mortgage will mature in about five years, and the property's value has increased several times. I'd greatly appreciate any input you might have on this situation.--D.S.C.

Answer: With five years to go on a 30-year mortgage, this is obviously a moot point with you, (Let's see--25 years ago. That would be, roughly, a 6% mortgage, right?)

The old equity/no-equity argument didn't even exist until inflation reared its head. And, in 1960, when you took out this mortgage (assuming it was for 30 years), the cost of living was rising just a tad more than 1% a year. It wasn't until the Vietnam War that it began accelerating sharply.

It has been said, too, that the real evil of inflation is not merely in the erosion of the dollar's purchasing power for those on fixed incomes, but in the fact that it leads us to do irrational and potentially dangerous things simply because of inflation. High on the list: buying more house than we either need or can afford on the theory that inflation will not only keep us out of trouble but give us a fat profit as well.

Thus, the basic argument against paying too much on your home equity went like this: Why pay off an 8% mortgage any faster than you have to when you can invest the same money elsewhere at perhaps 10%?

Debt and Inflation

"Also," according to Joel Singer, director of research for the California Assn. of Realtors, "in a highly inflationary environment, it was sound logic to be in debt to the fullest extent possible because the 'real' interest was quite low--or even negative."

In other words, why quibble about paying 12% on a home mortgage because, with a 13% inflation rate, you were actually making 1% a year by virtue of being in debt.

In addition, as Venice real estate agent Richard J. Rosenthal said: "When inflation was very high, the object was to put as little equity into a property as possible to tie up the biggest possible asset because inflation pushes up the value of the entire property, not just your portion of it."

Rosenthal's example of such leverage: "You pay 10% down on a $100,000 house when inflation is running at 10%. In a year's time the value of the house has increased $10,000 to $110,000. That's a 100% return on your invested capital. If you had bought it outright, free and clear, you would have only a 10% return on your invested capital. And, with a 10% inflation rate, that's breaking even."

But, in today's low inflationary cycle, this stratagem doesn't work any longer.

As Rosenthal said: "Typically, in a low-inflationary period, people bought the house they needed. In a high-inflationary period they bought the biggest house they could afford, regardless of need. Today's buyer is back looking at the house he needs, and while there are some special deals calling for only 15% down, 20% down is the norm now, with many paying as much as 25% down."

And, with a 4% inflation rate today, and with fixed-rate mortgages still commanding about 12.5%, the "real" interest rate on mortgages remains historically high--about 8.5%. (At the time you took on your mortgage at 6%, the inflationary rate was about 1%, which made your real interest rate about 5%. Long gone, certainly, are the "good old days" of a real interest rate of zero, or less.

Fundamental Change

"Today, it's a lot less painful and makes more economic sense to own, rather than be in debt--the last five or six years have seen a really fundamental change," Singer said.

The other old argument for maintaining as low an equity in a home as possible was based on the mortgage's assumability when it was time to sell out and move on to another home. It was considered a prime selling point to have a mortgage that your buyer could assume by paying cash for your equity (usually by taking out a small, short-term, second trust deed) in order to pick up your existing mortgage at a percentage point or two lower than the current rate.

"That's pretty well out the window now," Singer said, "because fixed-rate mortgages (except VA and FHA mortgages) are no longer assumable. Adjustable-rate mortgages, of course, are assumable, but they don't have much attraction because they are adjusted up to or near the current market."

Don G. Campbell cannot answer mail personally but will respond in this column to consumer questions of general interest. Write to Consumer VIEWS, You section, The Times, Times Mirror Square, Los Angeles 90053.

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