How To Get Home

Hey Eddie, should you pay any principle on your mortgage? There correct answer is not the same for everyone. For most Americans, the principle reduction of their mortgage is the only forced form of savings they have. Paying towards principle seems like a good idea and watching the mortgage balance decrease makes people happy. The idea of owning your home outright is very appealing. Let’s break it down and see what is right for you.

- Reasons to pay that mortgage off -

1. If you pay it off you will save future interest payments. True, the faster you hit zero the faster you stop paying interest. If held to maturity, most 30 year mortgages will have you paying back over twice the cost of your home.

2. With no mortgage payment, you will have the financial freedom to do other things in life. There is also the argument that having as little debt as possible puts you in a better position to handle the tough things (bad health, loss of job, loss of working spouse) that might come your way in life.

3. If you are close to retirement, if the mortgage is close to being paid, or if your aversion to risk would prevent you from investing your capital in anything riskier than a cd, then you should pay off your mortgage.

- Reasons not to pay off your mortgage -

1. The principle you do not send to your mortgage can be invested and will make a greater rate of return (no guaranty here.) It is not hard to beat zero, which is your rate of return on your equity in your home until you hit a zero balance.

2. Mortgage interest offers tax advantages. I agree with this, but you also have to recognize that paying a dollar in interest to save $0.28 does not make sense. Having the mortgage interest deduction opens the door to itemized deductions on your tax return which will beat the standard deduction most of the time. Consult your tax advisor for what might be best for you.

3. Your capital is more liquid. If you have to get access to your savings and those savings are tied up in the equity of your home, it takes both time and money (refinance costs) to get your equity out. ATM fees are much cheaper if your savings are in a competitive money market account.

If you think that 100% financing is too risky, read Dan Green’s piece on leverage. He breaks down the logic against a down payment and argues both sides. In the end, down payments make for lower mortgage payments. This reduces risk and is always a good thing. The argument is about what your true opportunity cost is of your down payment. Where else would you put that money to risk and what is that expected return compared to the rate of interest you would be paying on the mortgage.

Everyone has different goals in life. Understand what your goals are and have a plan to achieve them. For some people, having a mortgage helps them achieve these goals. For others, paying the mortgage off as fast as possible is what it is all about. They can both be right.