Paying Off Your Mortgage Early Might Not Be the Investment You Think It Is
There are Better Investments Available Instead of Paying Down Your Mortgage
Mortgage is Latin for “dead-deed.” Black’s Law Dictionary defines mortgage as an interest in land created by written instrument providing security for the performance of a duty or the payment of a debt. Mortgagees are the banks who lend money secured by real property and mortgagors are the borrowers who are obligated to repay the mortgagees for possession and title of the real property. Mortgages are synonymous with homeownership and there are dozens of mortgage products available for consumers to make the homeownership dream come alive, most typically a thirty-year mortgage.
However, with the thirty-year mortgage comes the thirty years of interest payments which is a daunting amount of money when viewed on the Truth-In-Lending statement a borrower receives when they have selected their mortgage product and begin the process of obtaining a loan. Thus, we consumers have looked at ways to reduce or eliminate the amount of interest we pay on a mortgage as an investment strategy. See the mortgage payoff calculator at http://www.bankrate.com/calculators/mortgages/mortgage-loan-payoff-calculator.aspx.
The question is: Does it make sense to use cash resources to pay down a mortgage and eliminate the interest payments? There are several factors that must be looked at before we can answer that question.
Mortgage Reduction Strategies Tout Elimination of Debt and Interest Payments
Most everyone has seen the advertisements for ‘mortgage reduction systems’ or ‘wealth building systems’ or ‘debt reduction strategies’ which all profess paying down your mortgage early. Like many investment decisions there are pros and cons which prudent investors must undertake when considering mortgage pay-downs. I have clients ask me this question all the time and I begin my response by asking several questions back to my clients.
Your Mortgage Interest Rate is Key to Mortgage Pay-Downs
Clearly a debtor-homeowner pays a lot of money in interest during a typical thirty-year mortgage – a $250,000 loan may need in excess of $800,000 to be paid off including interest; a $1,000,000 loan may require $3,000,000 in future payments. It is clearly enticing to know that one extra mortgage payment per year could wipe out several hundred thousand dollars in interest payments over a thirty-year period. It is also important to note if the mortgage has any pre-payment penalties associated with it which will cause a problem with this strategy – thus please look at the Note that accompanies the deed for any restrictions. However, if the interest rate on the mortgage were in the 2.5% to 4.5% range then there are other considerations – and possibly other investments which will be better investments than mortgage pay-downs.
Mortgage Interest Rate Tax Deductions Make Matters More Complex
Let’s put the benefits of the home mortgage interest tax deduction on the side for a moment. If an investor were able to get a 9% return on their money in an investment wouldn’t they be better off keeping the low interest rate mortgage and using their excess cash in the 9% investment? The 3.5% interest they are paying for the use of the mortgage money coupled with the tax deduction savings is a very low cost of using the mortgagee’s money. If an investor were able to get 9% investing in a high income producing dividend Real Estate Investment Trust (REIT), a high performance Exchange Traded Fund (ETF), or a publicly held stock or the S&P 500 (up 9.89% as of September 1, 2014 year-to-date) than that would be a far superior use of their money – the math is undeniable. Prudent investors will weigh these calculations and almost always come to the conclusion that there are better investments for their excess cash – than paying down one’s mortgage. The primary reason is because of the low cost of the mortgage – assuming one has a low fixed interest rate.
Knowing Your Priorities is Key for Your Financial Security
Investing your excess resources by paying down mortgage debt sounds like a great idea and maybe it will work for you. You should always pay down your higher interest rate debts first, i.e., credit cards, credit lines, student loans, car loans, etc. You also must consider funding your retirement savings before paying down your mortgage. Additionally, make sure you have also saved adequately for those periods of time when you might be out of work, or you become disabled. Moreover, I recently wrote a blog article that the average couple will need $220,000 for health care costs in their retirement years – in excess of their health insurance.
After you have considered all of the above and you are convinced that you cannot find a more profitable investment then consider paying down some mortgage debt.