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Most people who have mortgages dream of
a day when they won't. In fact, many
mortgage-holders speed up their payments
to make that day arrive sooner. Is that
smart, from a financial standpoint? Not
necessarily.
This point is highlighted by
a 2006 study prepared by economists for
the National Bureau of Economic
Research. About 38 percent of U.S.
households are making the wrong choice
when they speed up their mortgage
payments rather than use the extra money
to save in tax-deferred accounts such as
401(k) plans or IRAs, according to the
study. These households are giving up a
yield of 11 to 17 cents for every dollar
they spend on extra mortgage payments,
depending on their choice of investments
in a tax-deferred account.
While these survey results
are certainly interesting, they don't
tell the whole story on the issue of
making extra mortgage payments versus
investing. If you have a quantitative
nature, however, you can do a little
analysis on your own. For example, if
you were to pay down a mortgage with a
5.5 percent rate, it would be
essentially the same thing as earning
5.5 percent on some type of investment.
But if you are in the 25 percent tax
bracket, and you deducted your mortgage
interest payments from your taxes, your
5.5 percent mortgage would really "cost"
you just 4.125 percent. So, if you could
find an investment that paid more than
4.125 percent, you'd come out ahead by
investing, rather than paying down your
mortgage. (Keep in mind, though, that
you may have to pay taxes on your
investment.)
It might not be that hard to
find an investment that pays more than
your after-tax mortgage rate. But that's
not the only reason why it may make
sense to choose investing over mortgage
reduction. Here are two other factors to
consider:
-
Paying off your mortgage early won't
boost your ultimate return.
Obviously, you want your house to
appreciate in value. But paying off
your mortgage early won't make your
home worth more, though it will
enable you to pocket more of the
proceeds when you sell. On the other
hand, the more shares you purchase
of an investment, such as stock, the
greater your potential for boosting
your net worth. Of course, investing
also has its risks; when you sell
your stocks, you could receive more
or less than the original investment
amount.
-
Investing provides you with greater
liquidity than paying down a
mortgage. Once you make extra
payments to your mortgage, you can't
get at that money, except
indirectly, through a second
mortgage or home equity loan. But if
you were to invest the money
instead, you'd have access to it
(though, again, you might have tax
implications). This liquidity could
be important if you lose your job or
if you face an unexpected financial
need, such as a major medical bill.
Still, there's another side
to the mortgage/investment issue. If it
just makes you feel better to whittle
away your mortgage - or possibly pay it
off altogether - that's something to
consider. And if you're close to
retirement, it may make particularly
good sense, from both the psychological
and cash flow perspectives, to get rid
of that mortgage.
So, weigh all the factors
carefully when deciding whether to pay
down the mortgage or invest. Your choice
can have big consequences for your
future. |
