When Debt Repayment Plans Go Awry

So how could anyone argue that paying off debt is a bad idea?

You all can, if you’re approaching it in any of the following ways:

You’re paying off the wrong debt.
In the late 1990s, banks started pushing biweekly mortgage payment plans aimed at helping homeowners pay off their houses faster. By making payments once every two weeks, instead of every month, the homeowner would effectively make one extra house payment a year, shaving years—and thousands of dollars in interest costs--off their loans.

With a $200,000 mortgage at 6% interest, for example, the normal monthly payment would be $1,199.10. By making half that payment ($599.55) every two weeks instead, a homeowner could pay off the home five years early and save $47,282 in interest.

When the stock market started to tank in the spring of 2000, these plans got even more popular. People felt a lot better about "investing" money in their steadily-appreciating homes than they did "throwing it away" on stocks.

The problem with this approach is that many who pursued it were neglecting other financial goals or carrying other, far more expensive debt including credit cards and personal loans.

The average credit card carries an interest rate of 13% or more, more than twice as high as the mortgage in our example. Furthermore, you typically can’t deduct credit card interest on your tax returns, The deductibility of mortgage interest can reduce the effective rate you pay to 4.5% or even less, depending on your tax bracket.

There’s something else you should consider—inflation. Most people realize that higher prices gradually erode the value of the dollar, which means many things will cost more in the future than they do today. But inflation also makes debt cheaper as time passes. The fixed-rate mortgage payment that seems so onerous today will be much less so in 10 years and might seem almost an afterthought in 30 years.

Most people don’t understand that even modest inflation makes a fixed mortgage payment cheaper every year it’s in existence. Here is a quote from someone who did some research on mortgages, “My first mortgage, 28 years ago, was $271.60 a month. Had I stayed in that house, I would be spending far more today on my monthly utility bills than my mortgage!"