Lets say you had $400 a month to invest, would paying off the principal on your house be the best investment you could make.
I figure it is for 3 reasons, the lack of mortgage payments, lack of interest payments, and taxes.
If you had a 50k house at 6% interest that would cost $332 a month or $3984 a year for payments. Paying the $50k off would save you $3984 a year, which is 7.9% of the cost of the 50k. 7.9% annual return is very unlikely for a secure investment in anything else.
Also you are not going to have to pay an extra 70k in interest payments by paying the principal off early. So paying 50k now saves you 120k over the next 30 years.
Also you will not have to pay taxes in your investment. I once read that earning $1.40 and saving $1 are the same thing due to taxes (since taxes are roughly 30%, earning $1.40 means you have an extra $0.98 while saving $1 means you have an extra $1), and paying off your house is a tax free (as far as I know) means of investing. So if you multiply 7.9% by 1.4 you get 11% average annual return by paying off your house early. Yes I do think about these things for fun, I have my reasons.
However on the opposite side you have to consider that money loses value over time. $332 a month will not be worth as much in 20 years as it is now. And there are other investments that are tax free like 401ks or some IRAs. But the money you save in interest may counteract the role inflation plays, making this still the best investment you can make.
You also have to consider that you get a tax deduction on the interest you pay. So paying off your house sooner makes your taxes go up.
Another concern is that the house is not a very liquid asset. You can’t easily sell 1/10 of it to raise cash if you need some for some reason. You can get another loan based on the equity you have in the house. But a lot of the situations that come up where you need money i.e. lost job make it harder to get a load on favorable terms. So you should not deplete you emergency fund to pay down the house.
You pretty much have it all here - can boil all this down to the following:
[ul]The cost of having a mortgage is the monthly interest, after subtracting your tax deduction for home mortgage.
[/ul] [ul]The benefit of having a mortgage is whatever ELSE you could earn with that chunk of money, minus the income tax (at your current marginal bracket, not the average).[/ul]
Compare these two numbers, and you have a dollar comparison. Unless you’re in a very unusual situation you’ll generally come out better by paying off the mortgage.
But as Gaspacho mentioned, watch the liquidity angle. This can come up in funny ways, not just emergencies. For instance, will paying off the mortgage mean you’ll be taking out an auto loan on your next car, which you might otherwise have paid cash for? The auto loan will certainly be at a higher rate.
Another way the liquidity problem comes up is if you’re considering paying *down * your mortgage, but not paying it off. In this case remember that, while the dollar-for-dollar investment benefit is the same, you’re going to have *more * going out each month. You’re going to be paying the same mortgage payment, but less of it will be interest and you’ll get a lower income tax break. Your payoff date will be earlier, but until then you may wish you had some cash back in the bank.
There are so many variables it’s almost impossible to give a general answer. In general, paying off your house early is a good idea if you plan to live in that house long enough that you’d pay it off anyway, and there’s a chance you’ll lose your income at some point while you’re still making house payments.
A few reasons not to do this, though.
While it may be a good idea, it’s probably not all that great of an investment. It’s not very liquid, as gazpacho pointed out. Plus, its value will be highly affected by your local housing market, which you don’t have a lot of control over. Put the same money in a mutual fund and you get a diversified investment managed by a professional money manager.
A 30-year mortgage is also a great inflation hedge, as you note. Over the next 30 years your income is likely to go up (unless you plan to retire in that time period), but your mortgage payments will stay the same.
And I think your math is a little bit over-optimistic: your 7.9% savings includes principal payments, but that can’t really be considered “return”. And the tax situation isn’t quite as you describe it. For one, there are plenty of other types of investments that can grow tax-free, or with minimal tax impact.