debt and borrowing?

[Nigel]

I am looking for objectivist info on personal debt and borrowing. Specifically, I am interested in getting an objectivist point of view on personal home mortgages. It is my contention that home mortgages, in the way that they exist today, are no more than feudalistic indentured servitude. We were told this ideal that everyone should own a home by going into debt, by being subject to signing a contract and guaranteeing the efforts of our labor to a bank. It is my contention that one should save, and wait to afford a home without this unnecessary debt. Borrowing money is ok, only so far as that it is used for productive purposes, business loans. Borrowing money for productive ends is a component of capitalism, but borrowing money simply because you cannot afford what you want seems a little illogical to me.

[TLD]

I am looking for objectivist info on personal debt and borrowing. Specifically, I am interested in getting an objectivist point of view on personal home mortgages. It is my contention that home mortgages, in the way that they exist today, are no more than feudalistic indentured servitude. We were told this ideal that everyone should own a home by going into debt, by being subject to signing a contract and guaranteeing the efforts of our labor to a bank. It is my contention that one should save, and wait to afford a home without this unnecessary debt. Borrowing money is ok, only so far as that it is used for productive purposes, business loans. Borrowing money for productive ends is a component of capitalism, but borrowing money simply because you cannot afford what you want seems a little illogical to me.

There is nothing wrong with debt if you can handle it; and it can help with tax and family planning.

Not only is that not illogical, but it is not really a philosophical question.

I think you are ignoring the fact that such borrowing is a free exchange between you and a bank - both win.

[softwareNerd]

Borrowing money for productive ends is a component of capitalism, but borrowing money simply because you cannot afford what you want seems a little illogical to me.

Those aren't the only two options though. One might borrow for consumption under the following condition: one cannot afford to buy the product outright, but one can afford the installment payments.

Before the age of consumer finance, people would save up money to buy a home. This might take many years. Imagine a person who wants to buy a $180,000 home, saving $12,000 a year for 15 years (ignore inflation). With the ability to borrow, the person may save for 3 years to get the 20% down-payment. Then, he could borrow the rest of the money. Taking interest into account, he would end up paying perhaps more than $12,000 a year on his mortgage, and perhaps for 30 years. Nevertheless, one cannot say this is a poor decision. Rather, it is a preference that may make sense for many people. For instance, it might mean the person can move out of his parent's house earlier than otherwise, a couple might be able to get married earlier than otherwise, and so on. The extra money spent (on interest) is being used to buy something: not the consumption, but the timing of the consumption.

One can always take on more loan than is logical, just as one can consume more of something else than is logical. However, the basic mechanism of consumer borrowing is not flawed, particularly when it comes to very high priced assets like homes. What is happening is that some people who want to there their consumption (to their retirement years) are giving their buying power to those who want to consume now.

With that said, a lot of borrowing for lower-priced assets does not make sense. For instance, buying clothes and food on credit (true credit, not just using a credit card and then paying it up) does not really make sense for most people, because these are on-going expenditures and they ought to only be spending what their current income can bear. If they expect a significant increase in their income -- think medical student soon to become a doctor -- borrowing can be logical.

Edited July 25, 2011 by softwareNerd

[LovesLife]

I don't think debt in and of itself is a bad thing, and it's certainly not indentured servitude. I do think that many people who buy homes buy them for the wrong reasons. They also often don't really understand the nature of the loan they are agreeing to. Here are a few key points:

1. In an unmanipulated market in an area with a relatively constant population, a home is a depreciating asset; you should expect it to go down in real (pre-inflation) value, not up.

2. The interest you pay on a variable rate mortgage can change! Before you sign, make sure you can afford the payments if they should increase to the highest rate allowed by the loan.

3. When deciding whether you can afford to buy a house, be sure to include all of the long-term operating expenses: insurance, property taxes and maintenance (including infrequent big-ticket items such as replacing a roof, repainting, recarpeting, refinishing floors, etc)

4. What would happen if you were out of work for a few months? It can happen if you get sick or get laid off.

5. How long are you planning to stay in the area and in that house? If less than about five years, you may come out better if you rent, due to the transaction costs involved in turning a house around.

6. The more of your income that goes to pay the mortgage, the higher the risk in the event something goes wrong. To avoid trouble, buy less house than you can afford.

If you keep to principles like these, you can also make debt work for you -- for example, by paying the loan off with inflated dollars.

[Greebo]

Consumer debt for products which gain no value harms your ability to provide for your long term needs. As such, using debt to buy most of the consumer crap on the market that we are told daily that we need to have is, from an O'ist standpoint, immoral.

There are, however, cases where debt allows for an overall increase in productivity and is thus justified. Buying a home, for instance, in the long term allows you to stop paying rent and as long as you don't regularly refinance to borrow more, fixes your monthly living expenses to a degree. Borrowing to invest in new materials and goods for business purposes can result in greater returns than you would otherwise see by growing a business debt free, although the hidden cost is risk and it means you REQUIRE a higher income each month just to stay afloat.

So there are times where debt usage can be moral. More often than not, however, it's just indulging in impulse behavior.

[Ninth Doctor]

Borrowing money for productive ends is a component of capitalism, but borrowing money simply because you cannot afford what you want seems a little illogical to me.

What would you say to someone looking to go into business putting a mortgage on their (previously unencumbered) home to raise the funds, instead of taking out a business loan with a higher interest rate? Or, what if no bank will even give you a business loan, since you’re proposing a risky venture like developing personal computer software in the early 1970’s?

A home is just like any another asset that can be leveraged.

[aequalsa]

-- for example, by paying the loan off with inflated dollars.

That's the key bit of context. Right now you can get 30year fixed rates for under 4% in some cases. Taking on 4% money in a country on the brink of having to either deflate their currency's value,raise interest rates, or more likely, both, is usually a great idea. If you have $200,000 in debt At 4% with 10% inflation for 5 years(like we had in the 70s recession), then your basically paying back half of that amount. Further, when they raise interest rates back up, t bills could be paying 14% again easy. ( http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histret.html )

So, say you had the $200k in a shoe box and were deciding whether to pay cash or take on the 4% money...If you spend the $200k, you own a depreciating asset that you hope goes up in value some day. Whereas, if you were to put $40k down and hold on for a couple years you could be in the situation where you own a $200k(+inflation) house, with the equivalent of $80k($160k actually) in debt after inflation takes its toll, $160k in t bills making 10% a year up and above the 4% you are paying out on the mortgage, and not waiting for the value to increase because appreciation would just be a bonus. Plus you get extra points if you have an assumable mortgage at 4% when everyone else is paying 10% because that just caused your house to increase in value regardless of natural appreciation if you want to get out of it. And that's just tbills which is about the safest paper you could buy. If you invest well in securities or start a business with the $160k than the benefit could be orders of magnitude larger, but that's a whole other can of worms.

We live in a country with a debt based currency. Whether you like it or not, that's the context and if you loose sight of that, you'll end up being a martyr who responsibly saved up his pennies so that they could redistribute your savings through inflation long before you retire. It's really this simple. If you can borrow money at 4% and earn 5% on average over time, should you? I would say absofuckinlutely.

Disclaimer: I am not a financial planner and the above information is for entertainment purposes only. Any financial losses sustained by an individual following this advice is their responsibility solely. Personal context and capacity can vary too much.

[Nigel]

We live in a country with a debt based currency. Whether you like it or not, that's the context and if you loose sight of that, you'll end up being a martyr who responsibly saved up his pennies so that they could redistribute your savings through inflation long before you retire. It's really this simple. If you can borrow money at 4% and earn 5% on average over time, should you? I would say absofuckinlutely.

Thank you for this point. This is a good way of looking at it. My problem seems to lie in the fact that making sense of the irrational is not possible. In 2007/2008, before all of the defaults, the interest rates were between 1% and 3% higher than they are now. As more people have defaulted and risk in mortgage lending has seemed to decrease as property values continue to fall, the rational expectation is that interest rates would go up. Instead the opposite has happened. All the while, defaults and foreclosures are still prevalent. If interest rates were not artificially set and money had real value, would there still be a financial benefit to borrowing versus saving to buy a home?

[Dante]

If interest rates were not artificially set and money had real value, would there still be a financial benefit to borrowing versus saving to buy a home?

There would most definitely be a benefit to doing so, which would be basically moving home consumption up to the present; being able to move into the home now. You have to live somewhere, and if you're not paying down a mortgage, then you're probably renting. Mortgage payments get you closer to owning your home, while rent does nothing more than let you live there for another month. It's a trade off, and which route makes sense for any particular situation depends on context, but there's no reason to write off mortgages as inherently irrational.

[softwareNerd]

In 2007/2008, before all of the defaults, the interest rates were between 1% and 3% higher than they are now. As more people have defaulted and risk in mortgage lending has seemed to decrease as property values continue to fall, the rational expectation is that interest rates would go up. Instead the opposite has happened. All the while, defaults and foreclosures are still prevalent.

There are two components that explain the persistence of low interest rates. Firstly, the Fed is keeping short-term rates low and this can pull longer-term rates down to some extent and temporarily. Secondly, far from being in an inflationary period, we are in a strongly deflationary phase, which is typical following a major banking crisis. If we look only at narrow measures of money supply, it appears that the U.S. is seeing high money-inflation, which has not yet fully seeped through to prices. However, this is a credit-based and fractional-reserve based economy. Narrow measures of money supply are not useful as short and medium-term predictors. Much more important is the broadest measures, which include credit and potential credit. The market for loanable funds has buyers and sellers, just like any other market. Lenders are wary but so are borrowers. As a group, borrowers are in a phase where they are cutting back on their borrowing, and repairing their balance-sheets. So, while the supply of funds might have been pulled back, so has the demand for funds. Within the context of the Fed's antics, demand and supply comes into play, and the net effect is that lenders are willing to lend at fairly low rates if the borrower has decent credit.

If interest rates were not artificially set and money had real value, would there still be a financial benefit to borrowing versus saving to buy a home?

Yes. If the market were free, and if a large proportion of the population lived well within their means, interest rates would be very low. There would be less people trying to borrow, and more people trying to lend. The relative excess of lenders would cause interest rates to be lower than an economy where people borrowed a lot. In this context of low interest rates, many people would still find it worthwhile to borrow for very large purchases like homes. Edited July 26, 2011 by softwareNerd