Is Paying Off your Mortgage Early a Good Idea?

by Krantcents · 12 comments

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Are you paying off your mortgage early? Many personal financial experts suggest prepaying your mortgage or paying extra principal payments to pay less interest over the life of the loan.  You can save a great deal of money by just paying few extra dollars in your monthly payment, pay bimonthly, biweekly, or just make an extra payment. Are you paying off your mortgage early?

Recently, I read an article about Mark Zuckerberg financing his $5.95 million Palo Alto home.  He could easily pay cash for this or several homes, but he took a thirty (30) year mortgage at 1.05% ARM. Obviously the rate reflects no risk to the lender. This should not be a surprise, but most wealthy people do not mortgage their home. Borrowing at such a low rate is too good to pass up. I am sure he can utilize these funds more profitably elsewhere!

You may think that this is unique to wealthy people, but it is not! If you are in your twenties or thirties and take out a thirty (30) year mortgage for a home between $200-300,000, you may want to pay it off early. Is that the best use for your money? A mortgage provides the lowest interest rates long term particularly now. Why would you want to pay it off early. With interest rates so low, you should get better returns elsewhere.

If you can get a low interest loan for thirty (30) years, why pay it off early? Do you think your income just might increase over thirty (30) years? In United States, the national average for changing residences is every seven (7) years. It is too short of a time to make much of a dent in your mortgage balance. If you paid an additional $100 per month, you would have approximately $8,400 more in equity. If you invested $8,400 in the stock market, you would have a higher rate of return on the investment.

What should you do? Paying off your mortgage will create income by paying off your mortgage, but you should think about income instead. The stock market historical return is eight (8%) to ten (10%) percent. Remember your mortgage rate is approximately four (4%) percent and it is subsidized when you itemize your tax deductions. You pay a lot of interest over thirty (30) years and saving is a priority. You ca make a lot of money over thirty (30) years too!

Why you should pay off your mortgage early?

  • You will save a lot of interest! – A mortgage of just $165,000 at 4.3% will cost $293,954.40 over thirty (30) years. That is about $128,954.40 in interest. Who would not want to reduce that number?
  • Retired or near retirement? – You are retired or near retirement, you are probably in a lower tax bracket and cannot use the tax deduction. Investing the payment is not a good choice in retirement when you are trying to limit your risk.
  • No debt, no problems! – For many people, having no debt allows them to sleep better. Investment returns are not guaranteed and you can lose money. For some, it is forced savings and without it you would spend the money.

Why you should not pay off your mortgage early?

  • Investment returns higher than mortgage interest rates? – Mortgage interest rates are at historic lows and stock market returns are significantly better. Over time, the stock market has averaged eight (8%) to ten (10%) percent returns. Even on the low side it beats the mortgage rates by double.
  • Mortgage interest is a tax deduction – Depending what your tax bracket is you receive a subsidy when you itemize mortgage interest on your tax return.If you do not have a mortgage, your taxes will increase.
  • Investing the extra payments will save taxes – You can defer taxes by investing in your 401(k), pay taxes  now and invest in a Roth IRA or pay capital gains on the growth which is less than typical tax brackets.
  • Diversify your investments – Paying off your mortgage means you increasing your real estate investment. Investing your extra payments in some other investment is a good way to diversify. Real estate is illiquid  and you cannot sell it quickly or easily.
  • Additional income – Investing your money in a business or some other choice can generate income to pay for the interest during retirement. It should not be difficult to find safe conservative investments that will out perform the current low interest rates.
  • Refinance and downsize – My approach to mortgages is a little old fashioned! I believe you should keep the payment to no more than one person’s weekly income. If you keep the payment low enough, why bother paying it off?

Final thoughts

Are you paying off your mortgage early? I presented the pros and cons of paying off your mortgage early and you decide! Everyone is different and it is up to you. I think you should make your decision understanding the advantages and disadvantages of your decision. Some may feel that you cannot find an alternative investment that will outperform even these low interest rates. I understand, but you can chose a broad diversified index mutual fund that should perform better than these low interest rates.

When you pay down your mortgage, you are earning the equivalent interest rate on the mortgage. If you include the tax deductibility of the mortgage interest, it is even lower. Unlike an investment, it is assured, but lower. Some may sell their home in retirement and live on the proceeds. You still have to live somewhere and there is a cost for that. What will you do? I think it is best to think about your alternatives and decisions early and have a plan. Are you paying off your mortgage early?

 

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{ 12 comments }

moneystepper May 5, 2014 at 3:01 am

Whilst I understand there is a risk with keeping liabilities to fund long-term investments, if the cash-flow is well managed, it will usually be worth the risk if, in may situation, the expected returns exceed my costs by 3-4% or more. Often with mortgage debt, this is the case.

Krantcents May 5, 2014 at 7:06 am

Too often, people get caught up in paying down debt regardless the interest rate or funding their retirement. I think it is a question of choices and better to understand the consequences.

Holly@ClubThrifty May 5, 2014 at 5:38 am

I see both sides of the argument. We do choose to prepay our mortgage, but it’s mainly for personal reasons and because we don’t like debt.

What worries me about 30 year mortgages is that *most people* won’t prepay and may never pay them off. Having that mortgage payment then keeps them tied to their jobs and responsibilities and makes it much harder to retire.

Krantcents May 5, 2014 at 7:07 am

At these low interest rates, it may make far less sense. Make sure you max out your retirement savings before you prepay your mortgage.

Money Beagle May 5, 2014 at 11:56 am

Many people will put out reasons why it’s not a ‘good’ idea, and I can sometimes agree with them or see the points, but I’ve never yet seen a convincing reason why paying off your mortgage is a bad idea if you have the means to do so.

Krantcents May 5, 2014 at 1:05 pm

With interest rates this low, I think you should allow your capital to grow at a high rate of return. When you prepay a 3 or 4 percent mortgage, that is your return. Actually lower if you itemize your deductions based on your tax rate. The only exception may be during retirement and I am not sure about that either.

Untemplater May 6, 2014 at 12:34 am

The tax deduction shield is a nice one. And also being able to take advantage of low rates and earning more with other investments.

Krantcents May 6, 2014 at 6:59 am

In this very low interest rate environment, I think people are leaving money on the table if they are prepaying their mortgage.

Kylie Ofiu May 6, 2014 at 2:44 am

I agree. While paying off debt is good, it is about balance. Provided you know you will pay the mortgage off in time and are making good investment choices, then I would choose investing and increasing income over paying down debt.

Krantcents May 6, 2014 at 7:00 am

I agree! A mortgage is the lowest interest rate loan you will ever have.

Bryce @ Save and Conquer May 7, 2014 at 4:34 am

For most people, paying off the mortgage early is more of an emotional decision than a financial one. It sure feels good to know we don’t have to make that monthly payment. We do continue to pay the equivalent of our accelerated mortgage payment into our brokerage account every month. It’s the old out of sight, out of mind, savings scheme. We also only paid accelerated mortgage payments with “left over” money after our tax sheltered accounts were maxed.

Krantcents May 7, 2014 at 7:04 am

Good for you! With interest rates so low, you can earn much more by investing the same money elsewhere. For example, find a dividend stock that exceeds your mortgage rate and you are ahead.

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