Mortgage Debt As Inflation Insurance

If you’re under 40 years old, and live in the West, then the only world you’ve ever known is one of declining interest rates and reducing inflation expectations. In this world, inflation happens in textbooks and far away places. Last week, I tried to show that it wasn’t always so.

I want to share a case study about how you can use mortgage debt to provide inflation insurance. While I am very cautious with using leverage, mortgage rates are at a level where it made tremendous financial sense for my family to take advantage of the opportunity I’ll outline.

The numbers that follow are based on a deal that I did last month. You can find my workings in my Financial Education spreadsheet.


What I’ve done for this example is adjust the numbers from a December house purchase to reflect actual values per $100,000. These numbers are for Boulder, Colorado so you’d need to crosscheck for your own geography.

I assume a conservative debt:equity ratio of 50%. You might be able to borrow more but the interest rate that you’ll pay might increase.

Our loan provider gives us a single payment for the mortgage, taxes and insurance. 2/3rds of that amount relates directly to the mortgage and is fixed for 30 years. 1/3rd of that amount, as well as 100% of the other ownership costs, are subject to inflation. You’ll find a checklist for the costs of ownership on Page 55 of my book.

Using the scenario from last week, I imagine a decade of mild inflation (2.5% per annum) followed by five years of historically high inflation (7.5% per annum). This increases prices by 84% over 15 years.

Currently, for the type of property that we bought, the cost to rent is similar to the cost to own – about $300 per month per $100,000 of capital value.

What happens if prices rise by 84%?

  • My cost to rent is likely to increase by inflation and rises to $544 per month.
  • My mortgage payment is fixed so inflation only applies to half of my cost of ownership, which we assume rises by 84%. This means that my future cost to own is $424 per month.

In an inflationary environment, borrowers of low-cost fixed rate debt benefit relative to: (a) people that don’t own assets (the poor); and (b) people that aren’t leveraged (debt-free prudent citizens). What concerns me is the largest borrower of low-cost fixed rate debt is my government.

In an environment where public and private debt levels are high, inflation is a politically painless way to reduce the real value of debt. It is an “easy way out” for elected officials (and overleveraged companies/individuals) to deal with high levels of debt.

I have no idea if we’re going to have high inflation. However, if we experience high inflation, then it is valuable to my family to have a strategy where we can stay put with a payment that is lower than our cost to rent.

Additionally, even with moderate borrowing (50:50), the case study projects that the value of our home equity grows at 7.7% versus inflation at 4.1% per annum.

30 years from now, when I’m 74 years old, we will have a debt-free asset. The family will have the option to use this asset to take care of mom/dad in their senior years. If my wife and I pay down this loan over our working life then we remove end-of-life financial pressure on our family. 

The house we bought was the smallest that met our requirements in the one of the best neighborhoods in our city. You will be tempted to size up in a secondary location – this is a mistake. Choose location first then get the smallest place that meets your needs.

Convenience is my #1 criteria for “best.”


Other Considerations

This house is well located – I suspect that real economic growth in Boulder will be higher than the national average – real economic growth is a key driver for local property values.

Make sure that you get your cost of ownership calculations correct – there are many hidden costs of ownership that I cover in my book.

Inflation might not happen – make sure you are comfortable with low, and no, inflation scenarios (prices could even fall).

Make sure you understand what it would take for you to be unable to service your loan. I’ve been unemployed once per decade in my adult life.

Variable debt, especially loans that reset or are linked to the Prime Rate, can bite you in the butt. The 30-year fixed rate loan, effectively offered by the US Government, is an essential part of this case study. The inflation insurance comes from the fixed-rate loan.


Final Notes

The only thing I know for sure is the future will turn out differently than this projection. It will be fun to revisit this post in 15 years!

Prediction is not the purpose of running scenarios. The purpose of looking at alternative outcomes is to provide information so you can ensure that you are comfortable with any outcome.

One of the best decisions I made in my 20s was focusing on my career and maintaining complete geographical flexibility by renting. This allowed rapid career progression. Even in a rapidly rising market, I “made” much more money by excelling at work, than I would have done with real estate ownership.