Weigh Options Before Paying Down Mortgage
Most people who have a mortgage dream of a day when they won’t.
In fact, many mortgage-holders speed up payments to make that day arrive sooner. But that smart, from a financial standpoint? Not necessarily.
This point is highlighted by a 2006 study prepared by economists for the National Bureau of Economic Research.
About 38 percent of U.S. households are making the wrong call as they speed up their mortgage payments rather than use the extra money to save in tax-deferred accounts such as 401(k) plans or IRAs, according to the study.
These households are giving up a yield of 11 to 17 cents for every dollar they spend on extra mortgage payments.
While these survey results are interesting, they don’t tell the whole story on the issue of making extra mortgage loan payments versus investing.
For example, if you were to pay down a home loan with a 5.5 percent home loan rate, it would be essentially the same as earning 5.5 percent on an investment.
But if you are in the 25 percent tax bracket, and deducted your mortgage interest payments from your taxes, your 5.5 percent home mortgage would really “cost” you 4.125 percent.
So, if you could find an investment that paid more than 4.125 percent, you’d come out ahead by investing - rather than paying down a mortgage.
It might not be that hard to find an investment that pays more than your after-tax mortgage rates. But that’s not the only reason why it may make sense to choose investing over mortgage reduction.
Here are two other factors to consider:
- Paying off your mortgage early won’t boost your ultimate return. You want your house to appreciate in value. But paying off your mortgage early won’t make your home worth more, though it will enable you to pocket more of the proceeds when you sell. On the other hand, the more shares you buy of an investment, the greater your potential for boosting your net worth.
- Investing provides you with greater liquidity than paying down a mortgage. Once you make extra payments to your mortgage, you can’t get at that money, except indirectly, through a 2nd mortgage or a type of home equity loan. But if you were to invest the money instead, you’d have access to it.
Still, there’s another side to the mortgage vs. investment issue. If it just makes you feel better to whittle away your mortgage - or possibly pay it off - that’s something to consider. If you’re close to retirement, it may make more sense, from a psychological and cash flow perspectives.
SOURCE: Jackson Citizen-Patriot