Should you pay off your mortgage early, or use those additional dollars to save and invest?
While the American Dream has been to own a home and pay it off completely, ideally before retirement, is that actually the best strategy?
This week, we are sharing a guest post from our friend, Matthew Coyle of Sovereign Wealth Solutions in the Minneapolis – St Paul area. We love the fact that this article busts one of the popular financial lies of our culture – that you should always pay off your mortgage as quickly as you can. Matthew explains why you don’t need to be in a hurry when it comes to getting rid of your mortgage.
We’ve added our own comments in italics for additional clarification.
7 Reasons to Love a Mortgage
I am a big believer in home ownership. This does not mean, however, that I am a big fan of home equity. Why is this? Here are some reasons why:
Reason #1: Equity is Unrelated to the Value.
My home’s value is totally independent of my equity. Whether I have a big or small mortgage, my home’s value will most likely increase.
Whether your home is mortgaged to the hilt or free and clear, it will appreciate (or decline, in a falling market) the same. The lack of a mortgage doesn’t make your home a better investment.
Reason #2: It Costs Me $$$ Either Way.
When you pay off your mortgage, you are NOT eliminating an interest cost – only an interest payment. By locking equity in your home, you are unable to invest these dollars. This costs you money – but many people are unaware of this because they don’t receive a bill for this cost.
We refer to this as “opportunity cost.” Your opportunity cost is what you could have earned if you had used your dollars to invest at a profit instead of paying off low-interest, tax-deductible debt.
Reason #3: It’s My Largest Deduction.
There are very few deductions left for the middle class anymore. By keeping my mortgage, I am preserving the only large deduction I have left. This helps shield some of my income from taxation at a reasonable cost.
It is only an advantage to have the deduction instead of a smaller mortgage IF you save or invest the dollars you could have used to pre-pay your mortgage. If you can invest in a side fund earning only the same low rate of return as your mortgage, the tax deduction actually makes a 30-year mortgage more efficient than a 15-year mortgage.
If you find it hard to believe that a 30-year mortgage can be more efficient overall, look in your next Prosperity on Purpose ezine for a link and password to see our special video, “Mortgage Half-Truths: Why Common Mortgage Advice will Mislead You.” Filmed at a training for advisors, my (Kim Butler’s) husband Todd Langford demonstrates how saving in a side-fund makes a 30-year mortgage the better choice, numerically speaking.
Reason #4: It’s Cheap Money.
Nobody will lend you money to invest at a cheaper rate. Borrowing money against your home is properly utilizing your most valuable asset.
There is a difference between bad debt and good debt, and in many cases, mortgage debt is “good debt” when managed properly. There are many ways that a savvy investor can put a tax-deductible loan for 3.5% to work!
Reason #5: I’m Safer Because of it.
Banks foreclose on homeowners with larger equity first because it is easy to turn those homes for a profit. A large mortgage means you are less likely to be foreclosed upon if you can’t make payment. Most likely (if you have kept your equity in a safe side fund) this will never be a problem for you.
The more equity you have, the more you stand to lose in a foreclosure. However, our resident real estate expert, Kate Phillips, tells us that when you have more home equity, there are also more abundant opportunities to refinance or even get a second mortgage based on the property’s equity. The equity itself can give you options to save a home you wouldn’t have otherwise had.
As Matthew states, it is a great plan to grow your equity in a side fund. Even if your desire is to pay off your home fully, you’ll maintain more control by keeping the money you would have contributed to a mortgage elsewhere where it is under your control.
But until the side fund grows large enough to pay off your existing mortgage, you will be at risk. No matter how much equity you have – or don’t have – there’s nothing “safe” about not paying your mortgage! And as the 2009 mortgage crisis showed, plenty of homeowners with “underwater” homes with no equity lost them in foreclosure.
Reason #6: I Have Great Liquidity.
Keeping my home equity in a safe side fund means I have access to liquid funds in the event of an emergency. It also means I can move quickly if an investment opportunity presents itself in a time sensitive manner.
When you use your dollars to pay down your mortgage balance, your dollars have already done the only job you gave them to do. Unfortunately, it can be difficult to access those dollars to use them to do anything ELSE now, because they are locked up and under someone else’s control. By keeping the dollars in a side fund, instead of having an opportunity COST, you’ve got OPPORTUNITIES.
Reason #7: I Still Build Equity.
Even if my principal balance never declines, my home will (most likely) continue to rise in value. This means that I will continue to get all the benefits of my mortgage and living in my home regardless of whether my home is owned free and clear or not.
Instead of using extra dollars to pay off your home faster, use them to save and invest instead. You’ll have all the benefits of owning a home, plus all of the benefits of having access to dollars for opportunities.
Are you making extra principle payments against your mortgage? If so… is there a better, higher use for those dollars?
Thanks again to Mat Coyle for allowing us to use and share this article!
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