A commenter last week on Trent’s article about whether or not it’s ethical to walk out on a mortgage said something that I feel needs to be addressed. He wrote:
I must say that at first when I read this title I thought that it could be pretty cool to just walk away from a mortgage. I mean aren’t banks unethical taking all your money away from you with home loans and especially credit card debt.
There is a grain of truth in this. Some banks and banking officers have been quite willing to use their position as the “experts” to push financially-illiterate people towards loans and the like which they couldn’t afford. But what does this commenter mean “taking all your money away from you with home loans”?
I assume that he means charging interest, which is the only way they take your money (after all, if you’re just paying back the price of the house, that’s the same thing you’d be paying the seller if you bought the house with cash). But the bank isn’t ripping you off by charging you interest. They’re not being unethical unless they try to trick you about it or flat-out lie to you. Why?
Interest Is the Cost of Giving You Money
Why does a person take out a mortgage? Because she doesn’t have the money up-front to pay for the house. But by giving her that money, banks take on an opportunity cost (as well as a risk).
Suppose you’re a bank and you have $300,000. You could invest that money in the stock market. There, it might get anything from 2% to 15%, depending on how good the year is and how well you invest it. What motivates you to forgo years of earning interest off that money?
Guaranteed (ish) money. There’s no point in giving out a mortgage for charity unless you’re a charity. Giving out a mortgage to a person who will repay the loan with interest is a nice, solid way to make money off your money. You don’t have to worry as much about the variation in the market (as long as unemployment doesn’t skyrocket).
Of course, the person might walk away or miss payments. So there’s a risk involved, which accounts for a few more percentage points on some people’s mortgages. How many depends on credit history and how the bank views their source of income.
But banks are in no way obligated to lend you money. They certainly wouldn’t do so if they didn’t make any money off it. Where do you think the interest on your savings account comes from? The bank’s various investments, including mortgages.
Interest Is the REASON You Get the Money
So interest is the reason that you got that home loan in the first place. If it didn’t exist, banks wouldn’t be willing to give mortgages. People would probably not be willing to buy stocks either. Interest is the incentive that you give someone so they’ll give you what you want. (Micah chimes in: “Why would you want to trade my $100 for your $100? But look, my $100 comes with 5 extra dollars!)
It’s the same with a cup of coffee. Starbucks requires that you buy the coffee you drink. You get the coffee because you paid for it. They don’t sell at cost, either. They’re a business and they have coffee. They’re willing to give it to you, but only if you pay. Banks do the same with their money.
If you don’t want to pay interest, you must simply save up for the item yourself. Or grow/grind/brew your own coffee.
You Don’t NEED to Pay Interest
But you may consider the alternatives less-than-ideal. You can choose to rent homes throughout your life, or until you save up enough to buy a house outright.
You can constantly lease (rent) cars, but that’s generally a worse option than financing them. I know this may sound like heresy to some, but if you actually need a different car and you don’t have the money, you may have to finance it. That’s not an excuse to buy the newest, fanciest car even though money’s tight (unless that’s how you want to live…) but financing is a viable option.
Or you take out a student loan because you don’t have quite enough money to pay for all your college now. You could also put off college, but you may not consider that the best choice. That doesn’t mean you shouldn’t look for scholarships, grants, and earn money. But in the end it’s a choice.
In some cases it’s something worse than “less-than-ideal,” like in cases where you can’t pay the rent without a loan. But if you can’t pay the rent without a loan, you have more to worry about than interest. In most cases, it’s less urgent and more a matter of choice.
However You May See It as Worthwhile
Like buying anything, you have to decide whether buying this money is a smart shopping decision. Is what you’re going for worthwhile? Micah decided that a PhD now was worthwhile. (I decided that he was very worthwhile!) But we’ve decided that carrying a balance on a credit card is not worthwhile.
He decided that financing a car was worthwhile. Whether or not it was at the time, next time around we hope to pay as much as we can in cash (and limit our car-shopping to sensible ones we can afford).
You have to make the choice whether the item is worth saving for or if it’s better to pay more for the convenience of having it now. A college education is valuable at any time, but many people want it before they go into the work force. They believe it’ll pay off in higher salaries. If you’re already going to pay rent, you may see a home as worth financing because you plan to live in it for many years to come.
So Is Charging Interest Unethical?
On the part of the banks, charging interest just makes sense. It plays to the rules of our society—you can’t force someone to give you something, you have to pay them for it somehow. In this case, you’re buying money. And you’re buying it so that you can have more time. So you don’t have to wait until you’re 40 to buy your first house or so you can have a new book now instead of next week.
The only way the bank is willing to sell you their money is if you make up for the other opportunities they could have had to earn money with it.
If the bank does attempt to defraud you, deceive you about your payments, etc, then that is certainly unethical behavior. Some actions taken by credit card companies are unethical. Others get into very gray areas where you’re not sure they were trying to be unethical, but it still feels like there’s something wrong.
And sometimes the bank may not be defrauding you, but you didn’t fully understand the terms. Like using a balance transfer card to buy things that will accrue interest until you’ve paid off the transfer. Which is why it’s so important to read the fine print.
Do I believe that it’s unethical for a bank to charge me interest? No, I don’t think so at all.