Is a Mortgage a Debt? Why It’s Called Good Debt

A mortgage is a financial agreement allowing individuals to purchase a home by borrowing money. This amount, plus interest, is repaid over an extended period, often 15 to 30 years. While a home is an asset, the mortgage is a financial obligation.

Understanding What Debt Means

Debt refers to money or assets owed by a borrower to a lender. It involves a contractual obligation to repay the principal, plus interest, within a specified timeframe. Mortgages fit this definition as they are loans from a financial institution for a home purchase, requiring regular payments of principal and interest. A common misconception is that a mortgage is not debt because the home is an asset. However, the home is what you own, while the mortgage is what you owe.

How a Mortgage Secures Your Home

A mortgage is a type of secured debt. The loan is secured by the home being purchased, which acts as collateral. This provides the lender with a legal claim, or lien, on the property. This arrangement reduces risk for lenders, as they have the right to seize and sell the collateral if the borrower fails to make the agreed-upon payments. Unlike unsecured debts, such as credit card balances, secured debts like mortgages have lower interest rates due to this reduced risk for the lender.

Why Mortgages Are Often Considered Good Debt

Mortgages are categorized as “good debt” because they contribute to long-term financial well-being and wealth building. One primary reason is the accumulation of home equity, which represents the portion of the home you own outright as you pay down the mortgage principal. As property values increase over time, the equity in your home can also grow, enhancing your overall net worth.

Mortgages feature lower interest rates compared to other forms of consumer debt, such as personal loans or credit cards, due to the collateral provided by the home. Homeowners may be eligible for certain tax benefits, such as the mortgage interest deduction, which allows itemizing taxpayers to reduce their taxable income by the amount of interest paid on eligible mortgage debt. For mortgages originated after December 15, 2017, this deduction applies to interest on the first $750,000 of mortgage debt for a primary or secondary home. These financial advantages, combined with the tangible asset acquired, position a mortgage as a beneficial financial tool.

The Financial Impact of Your Mortgage

Having a mortgage impacts an individual’s financial health, starting with the debt-to-income (DTI) ratio. Lenders use this ratio, which compares your total monthly debt payments to your gross monthly income, to assess your ability to manage new debt and qualify for a mortgage. A lower DTI ratio, often preferred by lenders at 36% or less, increases the likelihood of loan approval and securing favorable interest rates.

A mortgage also plays a role in shaping your credit score. Consistent, on-time mortgage payments demonstrate responsible financial behavior and can positively influence your credit history over time. However, missing payments can damage your credit score, making it difficult to obtain future loans or credit at reasonable terms. The consequence of non-payment is foreclosure, a legal process where the lender takes possession of the home to recover the outstanding debt. Foreclosure results in the loss of your home and leaves a negative mark on your credit report for several years, impacting future financial opportunities.