Is It Sensible To Pay-Off Your Mortgage?

Photo by Ecanomee.

Though the topic about paying off your mortgage is highly debated, the right answer is the one that aligns with your overall goals and investment strategy.

There are two diametrically opposed schools of thought when it comes to carrying debt. Some investors prefer to own properties “free and clear,” while others believe that leveraging their property purchases is more financially sound. Common factors that affect the decision are your age, terms of your mortgage, other investment opportunities, and your tolerance for risk. Though the topic is highly debated, the right answer is the one that aligns with your overall goals and investment strategy.

First, let’s take a look at some advantages to paying off your mortgage early:

  • The most apparent effect is that you will eliminate a considerable recurring expense. Not having a monthly “nut” to pay will free up some cash and relieve a large portion of your financial pressure. The extra money can be used to make improvements, invest in new properties, or be put away into a slush fund.
  • Pre-payments will save you thousands of dollars in interest. As you most likely already know, a large portion of your mortgage payment goes to pay off the interest on the loan. Initially, the lion’s share is mostly interest, but as the loan nears maturity, a larger percentage is applied to the principal. Contributing extra money towards the principal early into your loan will slash the amount of interest you pay over the course of the loan. 
  • Immediately improve your cash flow. The money normally earmarked for the mortgage is now an asset. The newly acquired independence gives you the option to pursue other business opportunities or to invest in risk-averse financial instruments to build a nest egg for retirement.
  • Financial freedom can be exhilarating. Once you own the property outright, the lack of payment helps you sleep at night and relieves related stress. Also, should the real estate market take a nosedive or your business weaken, your property will be protected from foreclosure.

Now let’s take a look at some arguments for NOT paying off your mortgage:

  • One of the biggest reasons why proponents advise against pre-payment is the loss of the interest tax deduction. The interest deduction you are allowed to claim not only lowers your taxable income,it lowers the effective rate you’ve borrowed the money at.
  • With a lot of capital tied up in a property, you could be “house rich and cash poor.”Unlike stocks, bonds, or ETFs, which can be sold on a moment’s notice if you need cash, even a free & clear property may take some time to sell.
  • Funneling extra money towards your mortgage can add additional risk to your portfolio. The lack of diversification can leave you more vulnerable because you’re over-invested in a single property. Until your mortgage is paid off, you may not have the needed funds should another real estate opportunity become available. 
  • Another, perhaps lesser-known disadvantage, is the inflation hedge that mortgaged real estate provides. It’s a well-known fact that as prices of goods rise, you need more dollars to pay for those same goods year after year. So, when you lock in your 30yr fixed mortgage, you are bound to make 360 identical monthly payments on your loan through maturity. The inflation hedge gives you the advantage of paying your mortgage with the value of today’s dollars without having to account for inflation. As the years pass, your $1000 payment will be worth less in actual dollars, effectively meaning that you will be paying “much less” than the $1000 coupon payment. Do you know how much a gallon of gas cost 30yrs ago?

What About My Other Investments?

If your investment portfolio includes more than real estate holdings, determining whether it makes financial sense to pay off your mortgage or not will require some calculation. If you’re considering paying it off, you’ll need to figure out the return you’re getting on other investments and weigh that against the interest rate on your current loan. Remember, any extra payments made to lower your mortgage will bring you a locked-in return equal to the mortgage interest rate.

For example, if you have a fixed 30yr mortgage rate of 8%, and your stock portfolio is returning 6%, using this one calculation, it would make more sense to pay down the mortgage. However, if you were lucky enough to have locked in a fixed-rate at 5%, and your stock portfolio is still bringing a return of 8%, the better investment here would be to invest any money that you would have used to pay down your mortgage at the 8%. 

How To Pay-Off Your Mortgage Early

If you’ve decided that paying off your mortgage makes the most financial sense, there are few simple ways to help you get debt-free. 

  • Refinacing your current loan to a shorter term will save thousands of dollars in interest. But may lead to a higher payment that reduces your cash flow. Keep in mind that you will now be legally bound to make your higher monthly payments to stay current. If you can afford to make the slightly higher regular payments, refinancing will “force” you to pay off your loan earlier.
  • Thanks to the way compound interest effects the loan, merely making bi-weekly payments will save you lots in interest and take, at least, a few years of your loan. The way the math works out, you’ll essentially be making thirteen annual payments.
  • Similar to bi-weekly payments, making one or two double payments a year when you have the extra cash reserves will have a similar effect. Consider this, depending on your interest, making just one double payment a year can take 6-8 years off a 30yr fixed loan!
  • If it would be difficult to scrape together double payments even once or twice a year, try committing to a fixed amount. Even if you only allot $100 or $200 a month consistently to pay down the principal, because of compound interest, you’ll be able to pay off your mortgage a few years ahead of schedule.

Deciding to pay off your mortgage, or not, is a big decision and one that should not be considered lightly. Your personal financial situation will determine whether or not it makes sense for you. Factors like how close to retirement you are, the business’ cash flow, and how important it is for you to be debt-free all play a role in the final verdict. As always, when faced with tax and/or financial issues, it’s best to consult a professional to crunch the numbers to make sure your decision is financially sound. 

Posted in: 1. Property Owner Blog Posts, Investing Strategy

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