Do you still have a mortgage on your home? If you’re like most people I’m guessing you do. However, most people aren’t wealthy. There are many myths about why you should keep your mortgage. I’m going to dispel them in this article.
Before we get started, let me just say that I don’t have anything against mortgages. Many Americans, including me, could not have purchased a home without one. Mortgages are just a tool, similar to credit cards. And like credit cards, they are a great tool when used correctly.
I’m not here to demonize mortgages or the mortgage industry (well maybe just a little). I’m just amazed at the rumors that circulate in the financial press. The FICO hoax is one of my favorites (or least favorites).
The Home ATM
Around 1999 a few talking heads (“experts”) were recommending the homeowners take out the equity in the homes to purchase stock. That’s right; the financial “gurus” were recommending people put their houses on the line to buy into one of the most overpriced stock markets in history.
You’d think that after the tech bubble popped this idea would have popped with it. Not so, unfortunately. I see financial advisers continue to tell people not to pay off their homes because they can get a better return in the market. However, they fail to mention that that return is not guaranteed. In fact in a bear market like this, a guaranteed return around 5% to 6% could be pretty good.
Tax Deductions
If you pay off your home, you’re getting a return equal to your mortgage interest rate. What about tax deductions? What about them? First of all, you have to have enough deductions to itemize. These have to be more than the standard deduction. I’ve never managed to do that. In fact a majority of Americans do not itemize, so they get no benefit from the mortgage interest deduction anyway.
What about those that can take the write-off? If you have an expensive house and a large mortgage or other large expenses you’re already in trouble. If you have a lot of expenses your not able to save that money. By definition you’re spending it, not exactly the smartest way to get wealthy.
But what about the deduction? For every dollar you are spending on interest you’re able to deduct around 30 cents. This could be between 25 and 35 cents depending on your tax bracket. Let’s put this in perspective. I’ve found a very good example at americanchronicle.com. Lin Ennis has this typical mortgage example:
The Rodriguez family earns $100,000 a year. For federal tax alone, they’ll owe $18,330 (besides all the other taxes: state, county, etc.).
Let’s also say that their mortgage interest is $11,215. If they deduct the entire $11,215 interest from their $100,000 income, their taxable income is $81,670, not $100,000. Note, they deduct the interest off their taxable income, not off their owed taxes. That’s why the savings is not dollar-for-dollar.
The difference between the tax on $100,000 and the tax on $81,670 is about $3000. Therefore, the Rodriguezes will save $3000 on their taxes, not the entire $11,215 they paid in interest. Instead of paying $18,330 in federal income tax, they’ll pay $15,525.
In the example above the family is spending $11,215 on interest to save $3000. However, they’re total mortgage bill is $12,069.36. The total includes principle and any escrow payments. Do you see the problem with spending over $11,000 to save $3,000? It just doesn’t make sense.
Now what about the idea that you can make more in other investments? First of all taking a loan against your home, where you and your family live, to speculate in the stock market is the dumbest thing you could do. Seriously, think about it for a moment, if it’s not obvious why than I can’t help you.
Ennis also had this to say:
[T]he principle of “it’s better to pay cash for your home” does not always apply. If you have a very low interest rate on your home, and a high yield on some stable investments, it could be better to carry a home loan. It depends upon your yield—income minus outgo.
Today’s investment landscape is not very good for the saver. With high rate savings accounts offering around 3% and bond fund ETFs returning between 2% and 5%, stable investments just aren’t returning that much. Rates can change on almost any investment besides a CD. If you pay off a mortgage you’ve “locked in” a decent rate. A "a high yield on some stable investments" just isn't that easy to find.
Some People Are Better off with a Mortgage
Keep in mind that a small minority of high income Americans are better off with a mortgage. Notice I wrote high income, not wealthy. High income and wealth don’t always correlate. If you do the math and you’re better off with a mortgage, by all means, do what works for you.
For the Rest of Us
However, for a vast majority of Americans, paying off the mortgage makes sense. A home is a place to live and raise a family. If you lose your job or get sick or injured, can you still afford to pay your mortgage? For a vast majority of Americans, the mortgage is the largest monthly bill.
If you didn't have that bill every month, you’d have a lot more freedom. You can invest more money every month. You can follow you dream and/or start you own business. After all if you don’t have to worry about house payments, it’s a lot easier to make ends meet on a smaller income.
For me it comes down to freedom. I love having no debt. If I lost my job tomorrow, I could work at a fast food restaurant and still pay my bills. That’s what I consider freedom.
What about you? What do you think? Do you love having a mortgage? Do you want to pay it off? Are you not convinced? Please, speak leave a comment below.
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Comments
9 Comments so far
I don't think anyone likes having a mortgage, but it all comes down to a loss of opportunity when you have extra money to either invest or pay down your mortgage.
I disagree with your definition of a stable investment as including only bonds and cash-type investments. If you have a long time horizon, I would consider a portfolio with a large percentage of stock-based mutual funds (70-80%) a stable investment. When I say stock-based mutual funds I mean an intelligent and diverse asset allocation in several different asset classes (preferrably with low cost index funds) that have historically provide high returns(SP500, EAFE, Bonds, REIT, etc…)
Since the long term return of the stock market (8-12% depending on the assest class) is greater than a lot of fixed mortgages 5-7%, it would be better for you to invest in the stock market than pay off your mortgage. That, of course, does not factor in the potential tax benefits you discuss above, or any benefits available in most retirement accounts (preferential tax treatment and possible employer matching).
If you are risk adverse, i.e., won't invest in the stock market when you have a long time horizon, or desire the emotional satifaction that having a paid off home provides, it might best best for you to make paying off your mortgage a priority. But that doesn't mean it would be the best option for you financially in the long run.
Jeff,
I agree that in the long run the stock market is a good place to have your money. Right now I'm putting the money that used to go to my mortgage into the market!
…the question is, will you be better off financially because of your decision to pay off your house early? If stock market returns exceed the mortgage amount, then the answer is no you will not be better off financially.
For instance, let's assume you buy a home for $100,000 with a 30-fixed mortgage at 6% (~$480/month), and let's also assume you have $520 to spend paying down your mortgage or to invest in the stock market providing an annualized return of 8%.
Option 1: Take the $520 and invest it in the stock market at 8%. After 30 years you will have ~$775,000 and own your home outright.
Option 2: Take the $520 and pay down your mortgage first (which will be paid off after 103 months) and then use the $520 to invest in the stock market (for the remaining 257 months). After 30 years you will have ~$680,000 and own your home outright.
If you are looking at it from a completely financial point-of-view, paying off your home early is not the better option (in this example)…and these calculations don't take into account any tax benefits for paying home interest or benefits of investing in a tax-deferred retirement account.
That being said, if your mortgage exceeds your rate of return in the stock market option 2 will prevail. Thus, to get the extra return ($95K) you have to take on the risk that the market will return more than your mortgage interest is costing you.
I currently have almost enough to pay off my mortgage but haven't because I am trying to make sure I make the the right decision; one thing I do know is that I abhor risk. Just food for thought: I do remember reading in the millionaire next door that most millionaire aren't invested in the market either because 1) someone else is in charge of your destiny so instead of the market they invest in themselfs; all the money is funneled back into their business, hmmmm. So if most millionaires invest in themselves so they can control their own outcome and trust their management style as opposed to less ethical ones, why shouldn't I take this approach.
So Jeff & Chris…it's been a few months since this post.
How's that "invest in the stock market" plan working out for you right now? Anyone still want to promote that stable 8% return today instead of paying down debt — of any kind?
I was laid off from my job two 1/2 years ago. Therefore I've not paid any Income Tax for same amount of time.There is no work to be found in or around my area and I have been Living off of my Home Equity Line which is maxed out now.Can I still deduct mortgage interest and the interest I've paid on my Equity Line.
Can you please provide me with or direct me towards someone who may be able to help me in this matter? I honestly don't know what to do, as I've never been faced with this situation before.
Thank You in advance for your prompt attention in this matter.
Sincerelry,
Woody Finefield
PH.# 239 303 0526
email wfinefield@aol.com
Paying for a house in cash in 1998 after making it big in the stock market was the best thing I ever did. I have no debt and never will again, never! (Not including medical bills if I get them one day since I firmly don't believe in health insurance.
I paid off my 15 yr home mortage in 5 years on July 31 2009. There is nothing better than the freedom that comes with no payments to anyone — we are totally debt free and in our mid 40's. I am with Jim, I will never have any debt again and you know what we have now that we don't have any debt ? MONEY … and ALOT of peace. It is wasn't easy but it was WORTH it. I wish I could convince everyone to do this
Lee Ann,
I can't wait to pay off my house as well. I am refinancing to a 15 year mortgage and I setup a blog at http://www.payingoffmyhouse.com to keep me motivated towards my goal. I can't wait until I send the last check to the mortgage company. Just knowing that when the first of the month comes around and I won't have to write a huge check makes me happy.