My formula for buying a house allows users to "become debt free in 7-10 years." Personally, we haven't had a mortgage payment in over 10 years and I've detailed why we advocate paying off your mortgage. That said, I'm starting to have second thoughts on the issue.
As many of you know, we've been looking for a new house for almost a year. We'd like to move to a different area of town and have a bit of land as well. I have a fairly good down payment saved up and my plan had to always pay off the new house in 5-7 years max -- maybe as few as two or three years. But with mortgage rates as low as they are, it seems like paying off the mortgage early may not be the best way to grow our money. Instead, we could put the extra into index funds and likely make several percentage points more in return.
I know many people have advocated this method here before, but I've always rebutted it because that's not what we did (and that's what this blog is about -- how I've grown my net worth and how you can do the same doing what I did/am doing) and because the trade off was so close to being a wash (when we paid off our house, rates were 8%, so faster mortgage payments were a pretty decent return.) But things have changed in the rate world and maybe we'll take a different direction with our next house. Maybe.
I know that we're disciplined enough to keep saving/investing rather than spending our "extra payments" -- something that's a downfall for many who decide not to pre-pay a mortgage (they simply spend the extra they have left over, make no financial progress towards investing and don't pay down their mortgage either.) But I'm sure my wife will resist the idea. She's a "get rid of all debt" sort of person.
What's really got me thinking is this Consumer Reports piece on pre-paying your mortgage. The highlights:
While paying your mortgage is definitely a good idea (the alternative being possible foreclosure), whether to take cash you might otherwise invest and pay the loan off ahead of time is a trickier calculation. The decision has become even more complex lately given the ups and downs of the stock market and the downs and more downs of the housing market.
Our statisticians created a computer model to compare prepaying a mortgage with investing in a Standard & Poor's 500 Index mutual fund during a variety of market conditions.
It turns out that while home may be where the heart is, it's usually not where the heartiest returns are. True, in recent years and for short periods since 1969, home prices have climbed as much as 16 to 27 percent a year in some regions. But on average, they rose only about 6.5 percent a year during that period.
The longer you own your home, the less likely it is that mortgage prepayment will be the better choice.
Aside from the cold, hard numbers, there are other reasons you might choose one option over the other. If you need access to your money in an emergency, for example, it will be almost instantly obtainable if it's in a mutual fund and much harder to get to if it's tied up in your house.
On the other hand, many people find peace of mind in paying off their mortgages and owning their homes outright, especially as they approach retirement. That can make an investment in your mortgage a worthy choice, psychologically if not financially.
Still, the bottom line, according to our Money Lab, is this: Although there are exceptions, chances are you'll be better off putting extra money into a good mutual fund, not into prepaying your mortgage.
What's your take on the issue? Assuming someone actually follows through on the strategy, which is better -- investing or pre-paying -- in your opinion?