Why You Should Pay Off Your Mortgage

Why should I write posts detailing my thoughts on a subject when commenters here seem to be doing a good job of it? ;-)

Here's a comment left on my post titled To Pay or Not to Pay Off Your Mortgage that was in response to another commenter saying keeping a mortgage was a good idea:

To Aaron: Sounds like you're a mortgage broker from ditech.com or something.

1. How is a fixed rate mortgage "monthly payment" better than "0.00" nothing, nada, zip, zero payment? I don't understand the logic on this one!

2. Tax Advantage. This is the most misleading reason to retain a mortgage. The true value of this deduction is about 20 to 25 cents on the dollar. I'll gladly give you .25 cents for every dollar you give me. Heck, I'll give you .80 cents for every dollar you give me. Like me know which account to wire the money too. HE HE

3. Yes, you're right, your home does have a 0% rate of return, but the monthly payment you place in an IRA doesn't. How about this. Take a $200,000 @ 6% fixed for 30 years $1199.00 monthly payment = $231,676.00 in interest plus the original $200,000 purchased price. Total of $431,676.00. Ok. Let's pay off the same home in 20 years. Reasonable right. Let's take look. Interested paid $143,886.00. Total purchase price $343,886.00. Take that same mortgage payment of $1199.00 per month for 10 years at a return rate of 6% would = $196,491.00 in a tax free IRA. If may tax deduction saves me $2,000 per year over 30, I would have $60,000.

Ok so to recap the numbers:

• $200,000.00 Purchase Price
• $231,676.00 Interest over life of the loan At 6% fixed
• $431,676.00 Total Cost of home
• $ 60,000.00 Less Tax saving deductions
• $371,676.00 Total cost of home at 30 years

Pay the home off in 20 years:

• $200,000.00 Purchase Price
• $143,886.00 Interest over life of the loan At 6% fixed
• $343,886.00 Total Cost of home- skip tax deductions cause most people can't itemize anyway.
• $ 27,790.00 instant savings by paying home off.
• $196,491.00 Add money in IRA "Here's the real kicker"
• $224,281.00 Total savings and increase.

Oh, I forgot to mention that the home after 30 years would be worth $485,452.49 at a 3% Appreciation year over year. Total net worth $709,733 with a home free and clear for retirement.

4. Disability - Ok If it happens in the first 20 years of my example above I would hope they have disability ins or term ins in the event of a death to cover the home. If this is the only reason for obtaining a mortgage or keeping a mortgage then I need to place myself in a bubble free from people and disease.

My only acceptance of a mortgage and not paying it off early is if you're in your career early and you move a lot for upward progression (may want to concern renting) less hidden cost involved or for investments. Now, I do love those tax advantages.

Comments

[Terry]

If you think the total purchase price is bad, just think of the total RENT price (going up and up every year with zero equity or appreciation in your pocket).

Is this a great country or what?

[traineeinvestor]

Changes to the the value of a house that you intend to live in for a very long time should be irrelevant to the decision. It should be a comparison between the cost of the mortgage (after tax) and the expected return on the alternative investment and an assesment of the risks to both the finance cost and the return on investment.

With home mortages being one of the lowest cost choices of finance available (4.7-5.0% for me at the moment) and expected long run returns from equities at close to 10% pa (depending on which market you are investing in), I am quite comfortable not making early repayments and putting the money into equities.

In deciding to do this I took into account (i) that I have a sufficiently long time period (9 years) to reduce the risk of market fluctuations and (ii) we have two incomes and could deal with the consequences should anything go wrong. I do not lose any sleep over this decision. The market declines over the last few days have not changed my thinking.

[Eric G.]

I agree with traineeinvestor.
This post is an extremely skewed look at the positive of paying off a mortgage. I'm not saying you should never pay extra on a mortgage. But you definitely have to look at the risk and reward of alternative investments.

[Bob]

There are some problems with this model.

First, I don't see where the analysis takes in to account the additional payment amount required to pay the mortgage off in 20 years. The $200,000 mortgage would require a monthly payment of 1432.86 for a 20 year amortization. This would leave $234/month that could be invested elsewhere. This $234/month invested at a 6% return would amount to $47,370 at the end of 20 years and $121,845.55 at the end of 30.

That doesn't totally offset the difference, but it makes a big chunk.

[LivingAlmostLarge]

It's better to not pay off the mortgage if you are not saving $15.5k into a 401k and $4k into a Roth IRA. If you are then great, if not then the tax benefits of maxing out your retirement accounts first then prepaying the mortgage. You cannot go back after 20 years and say I'm ready to max out retirement, it doesn't work like that. Once the opportunity is gone it's gone.

To be it's best to maximize all retirement options then pay off the mortgage. But if you can only do 1, I'd save for retirement. Unless you are already close to retirement say 55 and only have 10 years.

[PJ]

Bob - Saving $234 a month at 6% would be $103,184 after 20 years and $221,758 in savings after 30 years.

[PJ]

The calculations use a flawed assumption. Rod advocates paying off the mortgage in 20 years but does not take into account that the monthly payment would be $1433, that is $234 higher that the 30 year monthly payment. He also notes the homes value after 30 years and that it would be owned free and clear for retirement. That is irrelevant as the appreciation would be the same and the home would be owned free and clear after 30 years for both of the secenarios.

A different analysis would be to compare the assets of two homeowners after 30 years.

Owner 1 with a 30 year mortgage
$1199 monthly payment
$234 monthly savings (difference between 20 and 30 year monthly payment)
$103,184 in savings after 20 years at a 6% rate
$221,758 in savings after 30 years at a 6% rate.

Owner 2 with a 20 year mortgage
$1433 monthly payment
$0 monthly savings (all his money goes toward the mortgage)
$0 total savings in 20 years (all his money went toward the mortgage)
$226,631 ($1433 savings per month for 10 years at 6% rate)

As you can see both homeowners would end up with roughly the same savings after 30 years, but what about at year number 20? Owner 1 has $100k in savings to use for college expense, emergencies, home repairs etc. Owner 2 has no savings at year 20 because of his higher mortgage payment. Your calculations show that he would have an “instant savings” of $27,790, but that’s not the case. The $27,790 is an unrealized difference between the total cost of the two homes used in your example. The tax savings for the 30 year mortgage would also be roughly $15 to $20 thousand (depending on the tax bracket) more than the 20 years loan