Debt Free?

What do you think it means to be "debt free?” I asked a client that this week as we were discussing financial issues. Her response - “Well, I suppose it means that you don’t owe anyone anything.” I told her I thought that was a great response and one that I would have expected her to give. While I can’t necessarily argue with that, I think I may have a better answer.

For me, being debt free means this:

You have the ability to pay off any debt you have, anytime you want.

In other words, you have enough cash on hand to write a check for whatever debt you may have. So any debt you have, you have by choice – not out of necessity. For example, if the only debt you have is a mortgage and you have more money in the bank than you owe on the mortgage, you are totally capable of being debt free.You simply choose to have the debt. I also think there is a pretty justifiable argument in most situations for having a mortgage loan. Let me show you what I mean.

Jim and Sandy are in their early 50's, buying a $400,000 home and debating whether or not to take out a loan or just pay cash. Their ultimate desire is to have no mortgage when they retire. Let's say they choose to borrow $300,000 on a 15 year loan instead of paying it all in cash. Their payment would be $2,175 per month at today’s rate. So over the 15 years, they would pay a total of $391,500 in payments. But since they kept the $300,000 invested and earned 6%, their investment would grow to $719,000 by the end of the 15th year. At 8%, they would earn over $950,000. Even at 3%, it’s $467,300 or $76,000 more than the payments made for the 15 year loan. So in each of these cases, they are better off.

I see way too many people who have a goal of paying off their mortgage while under funding their savings. Primarily things like emergency funds, retirement accounts or college savings accounts. Paying off a sub 5% mortgage when these type of investment accounts are not suitably funded makes no sense to me. Sure it is nice to not have to “pay the bank” each month, but cash is king. Put it to work for you and enjoy the benefit of compounding when you can afford it!

The Week Ahead
There will be some big economic events in both the US and Europe next week. A key report on inflation in the euro zone will come out on Monday. The next ECB meeting will take place on Thursday. Given the wide range of investor expectations, the ECB decision could have an impact on US mortgage rates. In the US, the important monthly Employment report will come out on Friday. As usual, this data on the number of jobs, the Unemployment Rate, and wage inflation will be the most highly anticipated economic data of the month. Before that, ISM Manufacturing, Construction Spending, ADP Employment, and ISM Services will be watched by investors.

The Week That Was
It was a very quiet week for mortgage rates. There were few surprises in the economic data. Talk of easing by the European Central Bank (ECB) was positive for US mortgage rates, helping rates end the week a little lower.

Mortgage rates are primarily set based on expectations for future inflation. The Fed has an inflation target of 2.0%. Most economists think that inflation rates well above or well below this level could have negative consequences for the economy. Recent readings for core inflation have been holding steady, below 2.0%. The Core PCE price index released this week revealed that core inflation was just 1.1% over the past year. Last week's widely followed Core Consumer Price Index (CPI) showed an annual rate of 1.6%. The majority view on the Fed, though, is that inflation in the US will gradually climb due to an improving economy and a tighter labor market. To prevent inflation from rising too far, the Fed is on track to end its bond purchase program later this year, and Fed Chair Yellen has indicated that the first fed funds rate hike is expected to take place next year.

The situation in Europe is very different. The economic recovery has been much weaker there. Recent inflation readings have been low and appear to be heading even lower. Traditionally, the ECB is known as a stricter inflation fighter than the Fed, meaning that it is more reluctant to add stimulus. Given current economic conditions, though, officials across the euro zone have suggested that the ECB may cut rates or begin to buy bonds to help stimulate the economy and increase inflation. Increased expectations for additional ECB stimulus helped push bond yields lower around the world, including US mortgage-backed securities (MBS).