What is it about the mortgage that makes so many people rally to its defense? You would think it's a member of the family. I'd really like to change my mind on the mortgage just to be a contrarian. However there is just too much evidence that paying off your mortgage is the best move for most people.
In my last post about debunking the mortgage myth debunkers, I examined some arguments for keeping your mortgage. I received a few good comments.
AJC, whose article on why paying of your mortgage is dumb I
I always like the historical 3.8% argument for the growth of real-estate … compound your house (or even your parents' house) and see if anybody that you know has ever bought a house appreciating at or below 'average'?
Didn't think so …
Actually I think a good many people are experiencing that right now. I know several who are selling or who have sold at a loss because they chose to move for a job. The real estate market is pretty rough right now. Real estate prices don't always go up. It goes down or it could stay at the same price.
However, this is a comment about real estate prices in general. I'm not against real estate investing at all. I think that real estate could be a better way to wealth than the stock market. So I don't think we're really disagreeing on anything except the historical appreciation of residential housing.
In fact, I've been reading more of AJC's blog and some of the articles are quite interesting.
Next up is Jeff. Jeff can always be counted on for good counter arguments.
"I really wish someone would come up with a list of convincing arguments for the mortgage."
1. Opportunity Cost
Can you find a reasonably secure investment that has a rate of return greater than your current mortgage interest rate? If the answer is yes, then you should buy that investment instead of paying down your mortgage. It is that simple.
Why not let your money work for you compounding at 8-12%, instead of using it to avoid your ~6% mortgage?
2. Tax Benefits
Although trivialized by this blog, the mortgage interest tax deduction is a substantial benefit received by millions of Americans each year. You appear to argue since only 35% of Americans itemized their deduction, that this tax benefit should be completely discounted. This statistic, however, is not persuasive and it provides no insight into the number of homeowners that have mortgages that cannot or do not take advantage of this tax break.
3. Refer back to Reason 1…making more money should be reason enough.
- Name one investment that is as secure paying off your mortgage with the same or greater rate of return. Don't forget to deduct taxes and capital gains if necessary.I've just started reading Fooled by Randomness by Nassim Nicholas Taleb. His premise as far as I can tell is that we very much underestimate risk. Seeing as how we've seen 2 major bubbles burst (possibly a 3rd with commodity prices) in less than a decade, I think it's an appropriate topic.Safety in the modern world (or at any time in the past) is an extremely rare and valuable commodity.
- If you are able to take advantage of this deduction then you should. However, paying $1 to save $.30 just doesn't make sense to me.
- There is no investment that is as secure as a paid off mortgage and that also returns 8-12%. I really wish there was, but I don't know of any right now. I'd be all over it.
What I'm really looking for is the formula I can plug into Excel that demonstrates that paying off your mortgage is a bad decision. As of yet, I have not come across it.
I'm really keeping an open mind on this topic. If I can find a convincing argument as to the merits of a mortgage, I'll post it.
Tags House & Mortgage Investing Mortgage mortgages Pay off Your Mortgage TaxesRelated Posts
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Comments
5 Comments so far
Jeff's point # 1. is indeed enough …
…I didn't state that your investment option need be “as secure as paying off your mortgage,” only that it be reasonably secure. Don’t get me wrong, I wasn’t suggesting that my Reason 1 was free lunch for investors, if you want a greater return, you’ll need to take on additional risk. Each investor should independently determine whether they can stomach the extra risk and if that risk worth the extra return.
I personally think that diversified investment in various stock and bond asset classes over a long period of time (around 30 years) is reasonably secure—and it historically has returned anywhere for 8%-12% (depending mostly on asset allocation and risk exposure).
I agree, right now, there doesn’t seem to be a short-term low-risk investment that will return an after tax return in excess of most 30-year fixed mortgage interest rates. About a year ago, several online savings accounts were offering 6% APY, and PenFed had a 6.25% CD promotion. Those might have tempted some of the more risk adverse people, as they were probably safer than paying down your mortgage.
As for your second argument, the value of the tax deduction is that it reduces the effective interest rate of a mortgage. For instance, if you have a 6% mortgage and receive 33% of the paid interest back in a tax break, then the effective interest rate of the mortgage is dropped by a third, i.e., it is effectively 4%. Thus, you should compare potential investments against the effective mortgage rate. That makes a 6.25% investment (even with 15% capital gains tax) not look too bad…comparably.
Also, here’s another Reason to not pay off your mortgage early…albeit a little one…
4. Liquidity
If you ever need to access the extra money, in most cases it would be cheaper and easier if it wasn’t tied up in your house. For instance, if you own stocks, you can sell them and pay some tax on the interest. If you have a CD, you might have to pay a penalty (couple of months worth of interest) to liquidate it. However, if you want to pull money out of your house, you have to take out another mortgage…which includes origination fees and if it is a second mortgage it will come with a much larger interest rate. I have even heard stories that some mortgage lenders will no longer provide 2nd mortgages if your 1st mortgage is an adjustable rate mortgage regardless of available equity.
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