Is It Logical To Have A Mortgage?

When someone secures a mortgage on their residence at a reasonable interest rate, what do they think about? Most people would say that they are glad they got a decent interest rate and long for the day when it will be paid in full and they will own their house free and clear and fulfill a core element of the American Dream.

Some people may have the means to pay their mortgage off in 15 years or even 10 years. This, of course, means larger monthly payments. But should they pay it off as soon as possible? What if they had lower monthly payments because they chose a 30-year mortgage. Then they would have more money to invest in stocks or bonds. Having a longer mortgage also increases the time you are eligible for the interest tax deduction on your federal income taxes.

I asked a few clients about this and got a variety of different responses—but with one theme in common. Home ownership is financial security and part of the American Dream of happiness and prosperity. If all else fails, they reason, at least I have my home. When fully owned it can’t be lost. If it takes longer to pay the house off, the threat of loss lingers and compromises a full sense of financial security that seems to come with home ownership.

This theme is what the father of behavioral economics, psychologist Daniel Kahneman, calls loss aversion. As human beings we are afraid of loss and do anything NOT to experience it. As a matter of fact, when we anticipate the possibility of a financial loss, our behavior changes in ways that are actually MORE risky, because we are trying so hard to avoid a loss. For example, if the numbers show that you would be better off to take a 30 year fixed mortgage (don’t forget to figure in an estimate of the forward moving inflation rate), you get the tax deduction for 30 years. In the meantime, if you put the money into a conservative investment that yields a solid return that puts you ahead of the game, would you do it?

Many people would not. They’d play it safe, avoid the anxiety of a possible loss and take a 15 year mortgage, even though they could make more money with a 30 year mortgage and a solid investment.

What would you do?

The answer gives you some idea about how you balance long-term gain against risk. From a purely economic perspective, you probably should take the longer mortgage. But if you lose sleep with even a conservative investment, it may not be worth it. In either case, this example helps if you become aware. Your awareness of the issues (risk tolerance, loss aversion) then facilitates thinking clearly about your options and deciding thoughtfully—rather than taking action without really consciously deciding.

What is your choice?

Let me know in the comments below…

Maggie Baker, Ph. D.
Psychologist – Financial Therapist
Author of Crazy About Money: “How Emotions Confuse Our Money Choices And What To Do About It”.