Mortgage Reduction - Advice On Paying Off Your Mortgage
"Pay off your mortgage after you pay down
other debts."
Mortgages: Is Bigger Better?
Many people believe intuitively that it is good to have a small mortgage, and
that paying off your mortgage early is a sensible objective. There are those who
disagree with paying off your mortgage, however.
For example, Ric Edelman, who wrote the book The
Truth About Money, argues that it is shrewd to have the largest mortgage
loan that you possibly can.
Is he correct?
The Best Use of $100,000
Suppose that you had a $100,000 mortgage, and one day you woke up to find
$100,000 lying under your pillow. Should you pay off your mortgage?
If not, what should you do with the $100,000?
- Pay off credit card balances
- Maximize retirement contributions
- Consider investments
Credit Card Debts
The first thing you should do with your new-found $100,000 is pay off your
non-mortgage liabilities, such as credit card balances. Typically, these carry a
higher interest rate than a mortgage. Moreover, interest on these loans is not
tax-deductible. Thus, it is very likely that compared to other liabilities your
mortgage represents a lower net cost to you.
Retirement Contributions
The next thing you should do with your new-found money is to make sure that you
are maximizing your contributions to tax-advantaged retirement accounts, such as
a 401(K) plan. If you are in the 25 percent tax bracket and have a 7 percent
mortgage, then the after-tax cost of your mortgage is 5.25 percent. If you can
earn more than that in a retirement account, you are ahead of the game. If you
work for an employer who matches some of your contributions to a 401(K) plan,
you are ahead even more.
Consider Investments
However, once we get past paying off other liabilities and investing in
tax-advantaged retirement accounts, there is not much to be said for keeping a
mortgage. For example, if we invest in taxable bonds earning 6 percent, then we
come out behind no matter how you look at it. Before taxes, we lose 1 percent (6
percent on our assets minus 7 percent on our mortgage). After taxes, we lose
0.75 percent (we earn 4.5 percent after taxes on our assets and we pay 5.25
percent after taxes on our mortgage).
We could invest our $100,000 in stocks and hope that they earn more than the
cost of our mortgage. However, there are less expensive ways to finance a
purchase of stock. Margin credit often is less expensive, particularly when you
consider other costs of a mortgage, such as private mortgage insurance (PMI),
and the fact that mortgage lenders keep some of your money tied up in escrow
accounts.
Moreover, one can use futures or option contracts to place large bets on stocks.
This is a point that often is overlooked by pop financial writers. Using futures
and options, it is as easy to take a large position in the stock market without
a mortgage as it is with a mortgage. We can use our hypothetical $100,000 to pay
off our mortgage without in any way inhibiting our ability to invest in stocks.
To put this another way: if you are afraid to buy stock using a margin loan
from your broker, then why should you feel comfortable about buying stock using
a mortgage loan from someone else?
On close examination, the case for using a large mortgage to fund one's
investment in financial assets does not stand up.
Forced Saving
A completely different argument for a large mortgage is the following:
If I did not have a large mortgage payment to meet every month, I would throw
away all my money.
The idea here is that a mortgage represents a form of forced saving. The theory
is that you will not save any extra income that you get, unless you force
yourself to invest in equity in your house by making regular mortgage payments.
Unfortunately, this form of forced saving does not necessarily work. Many people
who adopt this strategy then proceed to refinance their mortgages, taking out
larger loans. This defeats the purpose, because refinancing in this manner
undoes the equity buildup.
Conclusion
Having a large mortgage is not nearly as shrewd as Ric Edelman and other
self-proclaimed experts would have you believe. If your intuition tells you that
it would be healthier to pay off your mortgage as soon as possible, then that
probably is correct for you. We paid off our mortgage ten years ago, and we have
no regrets.
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