Investment Corner: Paying Down your Mortgage
If you are a homeowner with a mortgage, have you ever thought about paying off your mortgage early?
For many homeowners, there is no decision to make; you need to have extra money in your budget each month to allow you to allocate extra funds to your mortgage. In today’s economic environment, many families simply don’t have that extra cash flow.
For those who do have enough cash flow to pay down their mortgage early, the choice often boils down to a question of basic math versus quality of life; as in, will paying your mortgage off early save you money, and will it improve your quality of life in some way?
I’ll simplify this a bit, but the math works something like this: if you can earn a better rate of investment return on your extra funds than you can save by making early payments on your mortgage, then you should probably invest your extra dollars. If paying off your mortgage early will save you more than you are likely to make investing, you should probably do that.
As an example, on a home with a $500,000, 30-year fixed mortgage at 6% interest, an extra $100/month mortgage payment will reduce interest payments by approximately $57,000 over the duration of the mortgage, while paying off the home about 2.5 years early.
There are, of course, some things to consider in your mathematical decision. Taxes factor in, since investment earnings will likely be taxed and your mortgage interest could be deductible, if you are someone who itemizes deductions. The anticipated rate of return on your investments is a big question; historical returns have been much less predictable over 3-5-year periods than over 20-30-year periods. Unless you are investing in cash-like investments or bonds that are aligned with your future cash needs, it is very hard to know what your actual rate of return will be. Meanwhile, you’ll know exactly how much interest you are saving by paying off your mortgage early.
Suze Orman and Dave Ramsey, two of the most popular personalities in personal finance advice, both support the idea of paying your mortgage early, with a few caveats. They see the benefit of living debt-free as having a bigger impact on your life than whatever extra dollars you might be able to build in your investment account. Ramsey touts the psychological and financial freedom of fully owning your home.
The caveats? Both Orman and Ramsey agree that keeping some asset liquidity is important. Before paying down your mortgage, most financial advisors agree that you should have a 3-6-month emergency fund built up and all high-interest debt, like credit cards, paid off in full. It makes no sense to pay off a 7% mortgage while you have 25% credit card debt! In addition, it is important to note that once you put extra money into your home, accessing that money can be difficult. Home equity is not the same as cash.
While the mathematical answer might favor investing your extra funds if you are lucky enough to have a 3% mortgage, Ramsey would still encourage you to pay off your mortgage early. In his view, the psychological freedom that comes with living debt-free wins out.
Finance and investing are rarely as simple as deciding how much to invest and then picking a bunch of investments. The question of whether or not to pay off a mortgage early is a perfect example of the interplay of dollars, risks, emotions, and other factors. A smart financial advisor can help you evaluate the financial trade-offs, but some honest, in-depth conversations are needed before decisions are made. If you don’t have an advisor, those conversations need to happen with the decision-makers in your home.
However you handle your mortgage, invest smartly and invest well!
Larry Sidney is a Zephyr Cove-based Investment Advisor Representative. Information is found at https://palisadeinvestments.com/ or by calling 775-299-4600 x702. This is not a solicitation to buy or sell securities. Clients may hold positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
