You don’t get wealthy by paying interest.  You get wealthy by earning interest.

This is one of my favorite lines when it comes to personal finance.  While I am not adverse to all debt, I do think that a good path to wealth entails minimizing debt and not holding any bad debt.

While being a proponent of minimizing debt and being somewhat risk averse in terms of investing, I have great concerns regarding inflation now and in the future.

Many people who fear inflation are not adverse to debt.  They may promote various assets to hedge against inflation, or to even make money from inflation.  These assets could include stocks, real estate, gold, and other commodities. In many cases, they even find it useful to use debt in order to finance these purchases.  This is especially true when it comes to real estate.

Some have an even more flippant view of debt because they believe inflation will take care of the debt.  In other words, if the currency is depreciating by 10% per year, then you shouldn’t care about having debt at 5% interest.  After all, you are paying back the loan in a depreciating currency.  This can even be an excuse to take on more debt because it means paying it back later on when the money isn’t worth as much.

There are several problems with advocating more debt because of an expectation of inflation.

First, if you have a loan with a 4% interest rate, you are paying that 4% interest for as long as you have the loan.  It is extra money going to the lender out of your pocket.  Whether or not the money is rapidly depreciating, the money is exiting your account and going to the account of the lender.

Now, there is a counter to this that it would be better to borrow money at 4% interest and to get a return of anything higher than this (less taxes owed on the gains).  If you can borrow at 4% and get a return of 8% on this money, then it makes sense.

But that leads to problem number two with advocating more debt.  You don’t know that you will be right.  Maybe inflation (monetary or price) will stop. Maybe the currency won’t depreciate as much as you think.  Maybe the assets you buy won’t go up in value, even nominally.

There were people predicting runaway price inflation in 2009 with the Fed’s reaction to the financial crisis.  There are people still predicting runaway price inflation in Japan due to the massive government debt-to-GDP and the easy money policies from the Bank of Japan.  So far, they have been wrong.

Sure, if I knew that gold was going to go to $20,000 per ounce in the next 10 years, then I would borrow money at a low interest rate and buy as much gold as I could. But I have no idea that this will happen.

While I suspect that we will see higher price inflation in the future and that certain assets will go up in price, I really don’t know for sure.  This is why we diversify.  Diversification isn’t just about the investments that you buy. It also means diversifying your situation, which includes not overloading yourself with debt.

The best financial diversification is to have absolutely no debt and to have money left over to invest in assets that perform well in an inflationary environment.  You are protected either way with inflation or deflation.

Gold is an inflation hedge.  Paying off debt is a deflation hedge.  Paying off debt also just makes good sense.  The worst-case scenario with paying off debt is that you could have used the money for something else to get a higher return.

Mortgage Debt

I am currently refinancing my mortgage.  My current rate is just below 4%, and I have a little over 19 years left on it.

I was looking to refinance to a 20-year mortgage.  I could pay it off in about the same time while lowering my monthly payments.

However, when I was looking at rates in late 2020, the rates for a 15-year fixed mortgage were much better.  I have locked in a rate table that includes a rate as low as 2% on a 15-year loan.  This would include paying points (additional closing costs).

As of right now, I am going to refinance to a 15-year mortgage even though my payment will go up slightly (less than $100 per month, even with rolling in closing costs). I will pay off my mortgage in 15 years instead of in 19 and a half years.

I don’t know if this will turn out to be the mathematically optimal decision.  What I do know is that I think it is the right decision given what I know right now.

If I knew with absolute certainty that gold would go up 10% per year every year for the next two decades, then I would be better off doing a refinance into a 30-year loan.  I would also be better off taking out a large loan as a cash-out refinance.  The same goes if I knew that stocks or bonds would give this return in the future.

But I have no idea. I suspect that we will hit higher price inflation ahead and that gold will do well, but I am not certain.

What I am certain of is that I will pay my mortgage off in 15 years or less.  Even if we do hit much higher inflation, I will have locked in payments that I can afford.

I know there are people who are taking advantage of the low rates and refinancing into a 30-year mortgage.  There are people doing this even when they have owned their house for 5 or 10 years, or even longer. They’ll go from having, say, 20 years left on the loan, to restarting back at 30 years with a much lower payment.

While cash flow is important, I think it is shortsighted to do this in many cases.  You could keep refinancing back to a 30-year loan every 10 years and lowering your payment, but you will never actually get rid of the payment.  It is especially problematic when people do this and take cash out, thus pushing the loan balance higher again.  It is understandable for people who are really desperate and need the money, but it doesn’t make a lot of sense to do this if the money is being used for a new pool or new granite countertops in the kitchen.

There is no right answer to all of this.  Personal finance really is personal.  However, it is important to give proper thought to taking out more debt or even refinancing existing debt.

While I think everyone should prepare for higher price inflation ahead, you shouldn’t bet the farm on it.  This means not going into more debt on a possible false assumption that the currency you use will rapidly depreciate in the coming years.

If you want to become wealthy, you aren’t going to do this by continually taking on more debt. Debt can be useful in growing a business or buying real estate, but it should be used with careful thought.