Comments on: Should you Pre-Pay your Mortgage?

By: NM

NM — Fri, 04 Dec 2009 09:27:01 +0000

Another factor to consider when deciding to pay it off and have no more mortgage is whether or not you are carrying any other debt and what it’s cost is.
You also need to figure out with a prefessional where you are in regards to building an adequate retirement account. Being simple interest and generally tax deductible, your mortgage is usually the cheapest debt you have, and there are good cases for most people to not lock up their money by paying down the mortgage.

By: Howard

Howard — Thu, 26 Nov 2009 22:01:24 +0000

If you are subject to AMT, and you have a chunk of money doing nothing but sitting in a money market account with a stated “30 day yield of 0.00%” (that’s what my monthly statement now shows), why not pay down the mortgage? The fact that I have $100k in accessible funds does not hide the fact that I still have that $100k mortgage – being “essentially” debt free is costing me – because I am paying interest on the mortgage, get no benefit in deductibility, my cash is earning diddly (and even if money market rates were higher, I would be paying taxes on that income but still not getting mortgage interest deductibility) I am essentially paying my mortgage rate for having that money. It only makes sense having that money available if I can invest it in something that is going to guarantee me a risk free after tax return greater than my mortgage rate.

Considering the way things are between the economy and the stock market, I’ll take the guaranteed return of paying off the mortgage.

As to your points, #1 is clearly wrong in this situation – home equity is a guaranteed rate of return today with absolutely no risk.

#2, money you invest is compounding only if you reinvest the interest. Secondly, the fact that it is compounding only matters if the interest rate is higher than the mortgage rate (and you’re not subject to AMT).

#3 is a nice annectdote and obviously it’s true. You either finance something with your own money and then have the opportunity cost of possibly using that money for something else (as this entire discussion is about) or you finance using someone elses money and pay for using it. As I said, it boils down to whether the opportunity cost is more or less than the mortgage rate.

#4 every year more and more people are getting pulled into the AMT. As more and more people get pulled in, the more it makes sense to pay down the mortgage specifically because the interest deductibility is lost. A decade and two ago, this was one of the big benefits of taking the most money the mortgage company would give you – because the interest paid is deductible. Couple that with a low interest rate and nobody would lend you money at such ridiculously low rates. However, if you throw away interest deductibility, further reduce the amount you can make elsewhere with no risk and if you do happen to make money elsewhere you’re fully taxed on it. Again, more reason to pay the mortgage down.

“Let’s further assume that you can earn 7% in an investment which is taxed at capital gains rates.”

When you make assumptions, you had better look at what happens if your assumptions are all wrong. Is your 7% return guaranteed with zero risk? You’re guaranteed to be making your 7% year in and year out with absolutely no risk to your principal? Your answer is definitely no and therefore you are not making a valid comparison. Paying down the mortgage is a guaranteed return with zero risk. This is exactly why so many cities and municipalities are getting killed today with all of these newfangled derivative products that Wall St. put over on them – because they never considered “what if” their assumptions were wrong. If you are investing for a 7% return, when the Fed rate is less than 1% you are taking on risk – I don’t care what you are investing in.

#5 – as I mentioned, being “essentially debt free” doesn’t do it for me in my book because if you’re paying more than you’re taking in, it makes no sense not to pay off the mortgage. If you have no other savings or assets and need the cash for your emergency fund, then again, though you may be essentially debt free, you’re not debt free and therefore are still paying for the privilege of having that money on loan.

“Bottom line is that there is no right answer”

I would be more inclined to agree with you on that. However, based on everything you had written up until that point, that conclusion appears to come from out of left field in blatant contrast to all the points you’ve previously made.

In any case, this topic has gotten more airtime in the media recently as the markets and housing tanked and interest rates are at historical lows. It can makes lots of sense to pay down the mortgage depending upon the homeowner’s financial situation.

By: Suzie | Roof Repairs

Suzie | Roof Repairs — Mon, 16 Nov 2009 05:11:20 +0000

Thanks for a great post, the information was really useful and thank you to Drew that was a great explanation of the difference between those to, and you explained them in easy terms. I think I would like to financially free, but it is going to take me awhile to get there,

By: Tamir

Tamir — Wed, 29 Jul 2009 09:14:32 +0000

Steve, Thanks for sharing this good info post with us.

By: Mark

Mark — Mon, 27 Jul 2009 02:40:34 +0000

Will I have to pay capitol gains if my mortgage company refinances me at fair market value ( 412K worth 227K) ?

By: Justin

Justin — Sun, 22 Feb 2009 14:55:07 +0000

Steve,

Can you send me your calculations of 200,000K Net Interest?

I ran the same numbers you did and came out with 122,000. Trying to see where I messed up. You have a very good point though.

-Justin

By: Steve Heideman

Steve Heideman — Wed, 18 Feb 2009 06:12:11 +0000

Shawn, Yes. That is exactly what I am saying. If there is 0% appreciation, then the property still loses value do to the forces of inflation and loses relative value due to fluctuations between the dollar and other currencies around the world. Even if appreciation were positive, there could still be a nominal loss in value if the rate of inflation is greater than the rate of appreciation. Make sense?Steve Heideman’s last blog post: Comment on What’s Ahead For Mortgage Rates after the Stimulus Plan? by Steve Heideman

By: Shawn McGinness

Shawn McGinness — Fri, 13 Feb 2009 02:41:58 +0000

A lot of folks have written on this question – whether it makes fiscal sense to pay off your mortgage – but, this is the best I’ve read on the subject. Thanks for the great post.
In the first point, you say that money sitting in home equity is actually losing value due to currency devaluation and inflation; does this statement assume 0% appreciation? The real gain would be (home appreciation percentage) minus (inflation percentage), correct?

By: Drew Sygit

Drew Sygit — Tue, 10 Feb 2009 23:00:15 +0000

A great question to ask people is:

“What’s the difference between being debt free and financially free?”.

Most people confuse the two.

Financial Freedom means not having to worry about working for income to pay your expenses.

It can be attained in one of two ways:

1. Passive investments that generate enough consistent cashflow to cover your expenses.
2. A large “nest egg” that can be liquidated over time to cover your expenses.

Drew