Are consumers wise to prioritize mortgage debt?
September 17, 2013
While Americans have continued to improve their debt situation over the past year, the progress has primarily come from reductions in mortgages, rather than other forms of consumer debt. That's according to recent figures from the Federal Reserve that track financial obligations as a percentage of household income.
Overall, this ratio has come down over the past year, continuing a trend that began in late 2007. However, when you break out mortgages from other forms of obligations, it's clear that any progress over the past year has come from the mortgage side of the ledger.
Other financial obligations, which include payments on non-mortgage debt and other recurring payments, have even started to creep back up. To determine whether this emphasis on reducing mortgage debt is wise for consumers, it's important to consider the ways in which mortgages differ from other forms of debt:
- Mortgage debt is offset by a long-term asset. When you charge a meal on the credit card, the meal is usually consumed faster than the debt is paid off. Even something more durable, like a car, will generally start to depreciate almost as soon as you buy it. Thus, most forms of debt end up subtracting from household balance sheets. With a house, however, the debt is offset by a long-term asset. In fact, since real estate has appreciated over time, buying a house can be looked at more like an investment than as consumption. As a result, the payments you make toward a mortgage are more like savings than simply paying for past consumption, and given today's low rates on savings accounts, mortgage payments might be an especially attractive form of investment.
- Mortgages are generally a cheaper form of debt. Current 30-year fixed-rate mortgage rates are around 4.5 percent, while average credit card rates are around 13 percent. Current mortgage rates are especially low, but even under normal circumstances, mortgage rates are usually cheaper than other borrowing costs.
- Mortgage payments are generally fixed. Most consumers opt for fixed-rate mortgages with a uniform payment schedule. Compared to credit card payments, which vary from month to month and give consumers the option of paying anything between a small minimum and the full balance, the fixed nature of mortgage payments is both good and bad. It lends predictability to long-term budgeting, but it also gives consumers less month-to-month flexibility.
- Your shelter depends on it. Not paying your debts has serious consequences. Your car may be repossessed, your credit cards may be cancelled and so on. However, none of these consequences is as disruptive as losing your home, making your mortgage the most important debt to keep under control.
Given how much is at stake with mortgage payments, it's good that consumers have continued to lighten the burden these payments represent. However, since other forms of debt are generally more expensive and subtract more from household balance sheets, it's worrisome that these obligations are becoming a greater burden on consumers. Ultimately, being overextended in any way can put your ability to make future mortgage payments in danger.