We live in an inflationary world.  Prices have inflated almost every year in the United States since the end of World War 2.  There may have been one year in the 1950s where price inflation was very slightly negative.

Since Richard Nixon ended the last ties of the U.S. dollar to gold in 1971, inflation has been the default position.  We are accustomed to 2% price inflation or higher.

When it comes to personal finance, there is a general consensus that taking on certain types of debt – particularly mortgages – makes sense during times of high inflation.

As I write this, the government’s CPI numbers show that price inflation is running at 8.5% annually.  Many people are buying hard assets, and a house is the biggest hard asset most people can buy.  Therefore, even with mortgage rates going higher, housing prices continue to go up, at least for now.

It seems to make some financial sense to buy a hard asset like a house to pay back the mortgage in depreciating dollars.  And money used for a down payment won’t be sitting in a bank account losing purchasing power.

While most people won’t buy a house and cite the Federal Reserve’s policies of depreciating the currency as a reason for buying, they intuitively know that their money is being depreciated and that buying a house is something of a hedge against this.  They also see rising prices and want to get in before things go even higher.

Don’t Fall for the Mania

This is my cautionary commentary on being careful about taking on debt during an inflationary environment.  This includes buying a house.

The primary reason that it might be a bad idea to take on a big mortgage or other debt in an inflationary environment is that the inflationary environment may not last.  The Fed is talking about aggressive rate hikes (relatively speaking) and reducing its balance sheet.  Things could change quickly.  We could see a recession where price inflation quickly recedes.

But even if we could be certain that price inflation would remain elevated for a while, it still doesn’t necessarily make sense to accumulate debt.

As I like to say, you don’t become wealthy by paying interest.  You get wealthy by collecting interest.

This doesn’t change in an inflationary environment.  Even if you have a low mortgage rate at 3%, you are still paying 3% interest to a bank or some other financial institution.  It is money leaving your bank account.

So even if housing prices stay up, the only thing where you might make money is on the appreciation value of the house you buy.  Of course, this is no guarantee.  But even if this does happen, you can only make money if you sell and don’t buy something as expensive again.

Taking on a mortgage might be a good idea in lieu of paying rent.  When you pay on a mortgage, you are at least paying down the principal balance, even if it is small at first.  I find the problem is that people buy more house with more expensive features than what they can really reasonably afford.  The debt allows them to do this.

It goes without saying that you certainly shouldn’t take on bad debt unless absolutely necessary, even in a high inflationary environment.  You shouldn’t be accumulating credit card debt unless you absolutely have to for survival.

Student loan debt can go both ways, but it is unfortunate that many young people take on huge loans for a degree that may not be necessary.  Or, the degree may be available at another institution that is just as good.

Paying Down the Mortgage

You should really be trying to pay down any debt that you have outside of your mortgage.  This goes particularly for credit card debt.  It may be less important for a car loan if the interest rate is really low.

But what about a mortgage?

Let’s say you have a mortgage rate of just 3%.  (Mortgage rates have since gone higher.)  Why would anyone in his or her right mind pay down a mortgage with a 3% interest rate when price inflation is raging at 8.5%?

The question of paying down your mortgage or other debt isn’t about inflation.  It’s whether you can get a better rate of return elsewhere and the comparative risk.

Sure, the price inflation rate is 5.5% greater than the 3% mortgage interest rate.  But this doesn’t answer whether you should take additional funds that you don’t need in the near future and put them towards the mortgage.  The question is whether you can get a better return on that money elsewhere.

I know many will say to put the money to work for you.  You can invest in the stock market.  But the stock market carries high risk, especially right now.  You might just as easily lose money.  The 3% “return” on the mortgage pay down is a guarantee.

The bond market is not returning 3% for any short-term instruments.  You might be able to get close to 3% for a 10-year or 30-year bond.  And then you will pay taxes on the little bit of interest you do get.  If you are going to lock up your money for this long, why not just put it towards your mortgage?

This isn’t saying that I recommend that everyone pay down their mortgage faster.  You certainly don’t want to do this if you have any kind of liquidity problems.

The only money that should be used to pay down your mortgage faster is money that you don’t need any time soon.  When it is used to pay down your mortgage, you are locking it up until you sell or refinance.

When the mortgage is paid off, then you will derive the benefit of no longer having to make that monthly payment.

In conclusion, it may or may not make sense to pay down your mortgage faster.  It depends on your situation.

But the current high price inflation is not a good reason to avoid paying down mortgage debt or any other debt.  It would be relevant if interest rates were a lot higher to reflect the high inflation.  If you could buy a bond that pays 6% annual interest, then it might make sense to buy this as opposed to paying down a mortgage with a 3% interest.

At this time, interest rates are incredibly low.  There are almost no risk-free returns that are of any significance.  For some people, paying down the mortgage may be the highest risk-free return that they can find.