The case against paying off your mortgage!

by Krantcents · 57 comments

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Many personal finance experts suggest paying off your mortgage.  I realize that interest rates are very low on savings, but mortgage rates are historically low too.  If you itemize your income taxes, you can write off your mortgage interest and the government subsidizes your rate by giving you a tax deduction. The government is encouraging home ownership.  Why would you want to give that up?

If you pay off your mortgage, you have a debt free asset, but you cannot convert it to cash instantly.  I suppose you could have a line of credit secured by real estate.  I thought you wanted your mortgage paid off?  A line of credit is priced at a higher interest rate than a fifteen (15) year or thirty (30) year mortgage rate.  It usually starts at prime (3.25%) plus a margin based on your credit score.  Mortgage interest rates fluctuate by state or region, but it ranges from 2.5% to 3.5% depending on credit and terms.

Should you invest your money versus paying off your mortgage?  The year-to-date stock market performance for January ranges from a low of 4.06% (Nasdaq Composite) to a high of 7.22% (S&P MidCap 400).  Those returns may or may not continue for the rest of the year, but why would you pay down a loan that only costs you such a low interest rate?  If the stock market performs at historical (40+ years) averages, you will earn more by investing.  I realize there is more than dollars and cents that motivate people to pay off debt.

Real estate is a leveraged investment and financed at these historical low rates.  Real estate is starting to recover, although it is local.  In Los Angeles, there are multiple bids above the asking price with properties over $500K.  I realize that in other parts of the country, this would be a mansion, but this is not a mansion in Los Angeles.  In some areas of Los Angeles, property values are back to what they were before the real estate bubble burst.  If home values increase just five (5%) percent, you added $25K in equity for a $500K home.

If you own your home outright (no mortgage), you earned 5%.  If you have an eighty (80%) percent mortgage, your return on investment (ROI) is twenty-five (25%) percent.  In either case (mortgage or no mortgage), you can only realize your gain when you sell.  If it is your personal residence, you can exempt $250K as an individual or $500K as a couple from taxes.  This would not be true for your stock market investments, although you would only be subject to long term capital gains if you own the investment over one (1) year.

Final thoughts

I tried to raise enough issues to make you think about your investments.  I used real estate to build wealth by investing in rental property. Investing can be a personal residence, stocks, bonds or mutual funds. Yes, your home is an investment because it does appreciate in value despite what occurred in the last few years.  I am not telling you to not pay off your mortgage; however you should think about alternative investments before you do.  Many people would just sleep better at night when they have no debt.  What should you do?  Consult your tax professional before you pay off your mortgage!

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