Mortgage Debt: The Good News

Dudney, Donna; Peterson, Manferd O.; Zorn, Thomas
September 2004
Journal of Financial Planning;Sep2004, Vol. 17 Issue 9, p64
Academic Journal
The popular press, following conventional wisdom, frequently advises that eliminating mortgage debt is a desirable goal. We show that this advice is often wrong because mortgage debt acts as an inflation hedge and a hedge against declines in local real estate values. Mortgage debt is an ideal hedging instrument because it is tax advantaged and contains a valuable refinancing option in case interest rates fall. A numerical model shows that under reasonably realistic scenarios, some level of mortgage debt is valuable to many individuals. We consider three alternative investments for the equity freed up through the use of mortgage debt: TIPS (Treasury inflation-protected securities), REITs (real estate investment trusts), and the S&P 500 Index. Of these, REITs provide the best hedge against relative declines in local real estate values. The model can be used by financial planners to simulate the impact of mortgage debt and alternative investment choices on a given household's wealth over a wide range of plausible assumptions.


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