I have been told numerous times that it’s good to have a mortgage payment because of the tax benefits. I have money invested in conservative funds and stocks and am still losing a lot of money. Meanwhile, a huge percentage of my mortgage payment (with 6% interest rate) every month goes toward interest. I don’t see how the tax benefits of paying interest on my house offset the sure savings I would have if I paid off my house. I’d like to know what others think about this.
Dave Ramsey agrees with you…pay off the mortgage and invest your money. If you want tax deductions, donate the same amount to charity.
We paid off ours about two years ago. The 6% return was a sure thing and most years we get hit with AMT and don’t get full credit for deductions anyway. When the market has been up over the past two years I’ve occasionally felt stupid - when its down I’m quite impressed with how smart I am.
The real benefit is really cash flow flexibility. With no mortgage that NEEDS to be paid each month we are free put that money where we want. Most of it has responsibly been moved to the kid’s college funds and retirement funding - but there are months were we can now say “screw that - Christmas presents.”
That’s like saying you can save money by donating to charity. The tax benefit of a mortgage is that you can deduct the interest from your income at tax time. That’s a nice thing to wave in the face of silly renters, but if you pay off the mortgage, then you’re not paying that interest in the first place!
If you can pay off the principal balance of your mortgage, and you will still have enough in savings for a sizable emergency fund and you can do it without touching your retirement accounts, then go for it.
Maybe I’m missing something, but isn’t this a fairly straightforward calculation?
If (yearly interest paid on mortgage) minus (taxes deducted) is greater than (average yearly interest earned on investments) minus (broker fees), isn’t it time to pay off the mortgage instead of investing, assuming you can?
You’d want to consider opportunity costs (e.g., Dangerosa’s Christmas presents), etc., and of course your “average yearly interest earned on investments” will fluctuate some, but you can at least use the return on whatever your investments are from the last decade as a ballpark. Right?
Well, not only tax benefits, but wouldn’t it also make sense not to pay off your mortgage ASAP if, instead, you can invest those funds that provide a return higher than your rate of interest on your mortgage? I mean, say you have $300,000 that you could put down on a house. Historically, the S&P 500 averages anywhere from 7%-10% return. Wouldn’t you be better off putting that $300K into the S&P 500 (or whatever), taking the tax benefits, and paying off your mortgage slowly, rather than all at once? Granted, the 6% mortgage is guaranteed, and the S&P return isn’t, but if those conditions hold true, it seems to me paying off the mortgage right away isn’t the best long-term play for maximization your money. It does, however, buy you peace of mind.
Or is there a hole in my logic?
Nope that’s right. And most people do get the tax break, so you have to calculate that in as well.
But I don’t think this is a mere financial calculation. There are other factors at play - risk tolerance. Cash flow. Opportunity cost. Peace of mind.
That works and a lot of people take that approach, but IMHO the peace of mind of not having a huge debt far outweighs the potential gains on the principal.
Remember also that if you choose to invest instead of paying off the mortgage, you’re really only earning the difference between your investment’s APY and your mortgage’s interest rate. That may only come out to a couple percentage points in the end.
Oh, the other thing to calculate, if you are doing the calculations is that you get tax breaks on the mortgage, but interest income and capital gains are taxed on investments - so you have to calculate both sets of taxes.
And remember that although the stock market has averaged something like 10% (it depends on which time frame you grab), there are years where its lost 30% of its value as well as years where its gained 20%.
Right now, with the economy and baby boomers needing their money to retire, I’m betting on slow U.S. stock market growth for quite some time - 6% return might look good for the next ten years.
When looking at your return on investments, be sure to calculate whether you can get an employer 401(k) match on those investments. Many people do not even max out their employer match. If you can get a dollar for dollar or 50 cents on the dollar match on your investment, it is hard to beat that.
Another thing to keep in mind is whether your mortgage is your highest interest loan. Get rid of credit card, car payments, and perhaps student loans first.
The 401k match is big, as well as reducing your income, which saves taxes.
The other major advantage of the 401k is that you don’t have to pay taxes when you sell funds or stocks and purchase others.
Living in Japan, I can get a house loan of about 2.5%. Of course interest rates are low, and saving pay almost nothing. However, we get better returns on our investments in the States and Asia, so we’re not going to push too hard to pay off our mortgage when we sign it this year.
Where’s the money coming from to pay off the mortgage? If you’ve got it invested, you can still use it to cover unexpected expenses. If you use it to pay off the mortgage, it is gone, and an unexpected expense before you’ve built up the money again would either require you to get a home equity loan or something even more expensive.
Plus, if investment returns have fallen a lot, it is very possible that interest rates will also and you can refinance.
Wow, lots of good points! Thanks, everybody. It’s true, Voyager, that the liquid money will be gone if I pay off my mortgage (as opposed to investments). But it’s also true that I’d have an extra $1200/mo. that I’m currently paying the mortgage co. My employer matches my IRA payments, so I’m thinking that’s a better way to go. The point about interest rates going down and being able to refinance at an even lower rate is interesting too, though. FTR, I have no other debts. I’ve paid off my cards and student loans and we own our cars (and my motorcycle) outright!
I would strongly suggest that you actually calculate the total dollar effect of “a couple of percentage points” over a long period of time. For instance if someone is investing a thousand dollars a month over a thirty year time period that couple percent yields an additional $500,000. The market is doing poorly which leads people to mistake the current investment climate for long term expectations. With your tax deduction a 6% mortgage might have a true ‘cost’ of 4.75%. For most investments you are likely to reasonably expect a higher long term return. This makes investing, even during the painful periods, likely to be the best answer.
I actually think Suzie Orman and company have created a problem by taking a philosophy too far. With decisions like this it is important how things make you feel, but you should take the time to quantify what the decision will cost over a long period of time to make sure you are willing to pay that price for your feeling. Consider for instance, a 40 year old who is too concerned about market volatility to invest in anything but CDs. If that person wants to retire at 65 that decision about market risk could cost hundreds of thousands of dollars over 25 years and leave them unable to fund retirement. In that case they are ignoring long term damage to feel good today.
If I were the OP I would do an impartial calculation of costs and benefits and attempt to make sure that whatever decision I was making wasn’t a reaction to short term market movements.
Good suggestions. The question is whether these are short term market movements and whether things will get better anytime soon (ie - before I retire, which I hope is in the next 15 years). The only known quantity here is the interest I’m paying for my mortgage. And most of this interest is up front!
I don’t think anyone’s mentioned this yet, but one big factor that makes paying off your mortgage not quite the same as investments is that you can’t live in an investment. Part of my retirement plan is having a paid-off house that we can live in mortgage-free. Having income coming in as a retiree is critical, but so is having few expenses. Here in Canada where we get no tax breaks on our mortgage interest, I have every intention of paying off my mortgage early (we’re cutting something like six years off of our mortgage simply by paying bi-weekly instead of monthly).
I own a house and a vacation condo. i own both outright. I’m a way crappy investor. I set aside a significant amount of cash for a financial advisor to invest. The man was a retard. I actually have gone negative after a long term relationship with him… I bagged him and all current and future stock investments are mine and mine alone. I can make stupid stock picks with the best of them. I do not worry a bit about losing my house. Peace of mind is worth quite a bit to me. It is not always that easy to get a guaranteed ROI. I am happy with my lack of investment opportunity on the value of my house. I believe in a balanced portfolio, but have never been able to have my investment income beat the mortgage interest plus a tax penalty over the long term. I lost my job quite a while ago, but I’ve never worried about losing my house. Monies above and beyond this I am attempting to invest. Beware of advisers that tell you that they can beat the interest rates on your mortgage. YMMV.
If you are a superior investor than me, and are not worried about short term cash flow problems that may cause the loss of your house, you should keep a high mortgage and invest your money wisely. I hope you are a lot better than I.
The other problem that I have is people who have not paid off their mortgage by the time they retire. My theory is that at the time of retirement one should minimize their expenses. My brother has bought a very expensive condo with a very large mortgage. I am unclear where he is going to get the money to pay his mortgage after he retires.
That’s really the big downside to “you can make more money in the stock market.” You CAN, you can also loose your shirt. At least if you pay off your house and its value decreases, you can still live in it.
We threw about $2000 into an eTrade account in 1999 - playing stock picks. About the same time we bought our house. Our house is paid for. We closed the eTrade account last year and took out our $350. Lucent and Sun - they didn’t do so well…
You don’t know the half of it.
That’s the problem. You play stock picks and you expose yourself to a lot of risk. You may do really well, you may do really shitty. Find some low cost ETFs that track major indices and, over a 30 year period you should, if historic S&P rates hold true, average out at 7-10% APY.