Dr. Mike Walden
North Carolinians are being asked to consider a big mortgage for the state. Totaling $2 billion, the mortgage would allow the state to build a variety of projects, including university and community college facilities, water and sewer infrastructure and recreational offerings.
There are two key questions for voters to ponder: First, is mortgage financing appropriate? Second, are the projects worthy?
Although I’ve used the term mortgage financing, the technical term is bond financing. But since the two perform the same financial function, let me explain bond financing by referring to a mortgage.
Let’s take Mr. and Mrs. Smith as an example: They are young, without children and settled in their careers. They live in a rented apartment. But they’ve now decided to start a family, so they need more living space. They also would like to own rather than rent. They believe ownership will give them more control over their living space, and they won’t have to answer to a landlord for any changes they would like to make to their residence.
Yet the problem the Smiths face is money. The home they want to purchase is priced at $200,000. Although the Smiths have some money ($20,000), it would take them several years – maybe 20 – to save enough for the full purchase price. And by that time, the home’s price would be more and interest rates may be higher.
The alternative for the Smiths is to borrow most of the purchase price through a long-term loan called a mortgage. They repay the mortgage in monthly payments – where each payment pays interest on the loan as well as a part of the original loan amount – over several decades.
Using mortgage financing, the upside for the Smiths is they get the home now, and they are able to use and enjoy the home while paying for it. If they had to wait perhaps 20 years until they could pay cash for the home, their children would be in college!
The big downside of mortgage financing is the Smiths will pay more total dollars over time to purchase the home. If they bought the home with cash, they pay $200,000. Using today’s interest rates and a 30-year repayment plan with a mortgage, the Smiths would pay $340,000 over the three decades. Recognize, however, most financial analysts argue the two amounts aren’t directly comparable because the dollars are paid at different points in time when the values of the dollars are different.
Bond financing of state projects is exactly like mortgage financing of a home. By borrowing the money, the state gets to build the projects now and pay for them while reaping the benefits from the projects. The alternative is to wait until the state has saved the money to pay cash, meaning the projects will not be developed until years later. However, with such build-as-you-have-the-cash financing, interest costs are avoided.
This difference in financing methods leads to the second question: How worthwhile are the projects to be financed by the state bonds? If the Smiths decide to purchase their home with money borrowed through a mortgage, it’s likely a big reason for their choice is the ability to have the home now. If they’ve decided an owned home is the best type of residence for raising their children and aging into mid-life, then the sooner the Smiths can have the home, the better for them.
North Carolinians have the same question to answer about the bond package: How important is it to have the projects funded by the bonds built now rather than later?
With 10 million people now in North Carolina, there are potentially 10 million answers. I can only offer some basic information for helping my neighbors and citizens form their answers.
North Carolina is one of the fastest-growing states in the country. Our 10 million residents today are expected to grow to over 13 million by mid-century. This means more use of state parks, more flows through our water and sewer systems, and more students learning at our public community college and university buildings – all functions that would receive funding for expansion from the bonds.
Two-thirds of the bond money would pay for higher-education construction projects. One forecast that most futurists agree upon is the increased importance of formal education beyond high school for most workers. Machines and technology will take over many of the routine work tasks in coming years, making workers with advanced cognitive and decision-making skills in the highest demand.
Then there is the cost of the bond financing. Interest rates are now at near-historic lows. But the Federal Reserve has already announced a plan to raise interest rates in the future. So borrowing now could lock-in today’s relatively low rates.
Still, even with the low interest rates, there will be extra dollars paid in interest costs using the bond financing. So – just like for the Smiths – the essential question is, How much do we want the projects funded by the bonds? Do we want them now, or can we wait until later? This is our big “you decide.
Dr. Mike Walden is a William Neal Reynolds Distinguished Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of North Carolina State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy.Share: