Why Paying Down Your Mortgage is Risky
November 12, 2014
In Latin, the word mortgage means “death pledge”. No wonder many people want to get rid of their mortgages as soon as possible. Many homeowners have dreams about making that last mortgage payment and the party that will ensue, but leaving emotions out of it, getting rid of your mortgage early may not be the best thing for everyone, especially in today’s low interest environment.
While a mortgage represents a house payment for most people, it is essentially the money you pay back to the lender who fronted you money for the house. Just like any borrowed money, there is interest involved and that interest rate will generally determine if you should be paying off your mortgage early or not.
Here are some situations where just paying the minimum payment on your mortgage may be a good idea:
1. High interest debt: If you have any credit card debt, which many people in this country do, any extra dollars that come your way should be used to pay that debt off. Interest rates for a 30 year fixed mortgage nowadays are around 4%. Interest rates on credit card debt, which is unsecured debt, can vary from 15-25% and even more depending on the card. Paying off the card in this situation is a no-brainer but if there is any other higher interest debt such as student loan debt or business debt, that should take priority over the mortgage.
2. Low retirement savings: Mortgaging your retirement in favor of your house payment (pun intended) can be a poor financial move. 401k’s and IRA’s have very favorable tax laws, so not taking full advantage of these means you will most certainly be leaving money on the table. At the minimum, if your company offers a match on your retirement contributions you should contribute enough for that. If your company matches your contribution dollar for dollar, that’s a guaranteed 100% return on your money! Giving up tax friendly retirement money in favor of getting rid of your mortgage a little early is not the right move.
3. Interest deduction: If you have a rather large mortgage or are early in your home owning career, you most likely are getting a tax deduction on the interest and taxes you pay along with your mortgage payment. That means that with each extra payment you make, you are diminishing the tax benefits of owning a home. While this is not a compelling reason in itself, if you have other debt to take care of it’s nice to know that keeping the mortgage around will give you some tax savings.
4. Liquidity: While paying off the mortgage will free up a good chunk of change every month, it essentially transfers risk from the bank onto you. If your house is worth $500,000, having it paid off doesn’t mean that you can just reach into your pocket and take out $500,000. The only way to see that money is by selling the house or borrowing against it, neither being the most enjoyable of tasks. Shifting your extra money into your retirement accounts will ensure that you can tap it when you need it during retirement.
5. Not a guaranteed return: Housing prices generally increase over time, but as the housing bubble demonstrated, it can crash at any time. If you’re faced with moving to a different city because of illness or family reasons, and the market has taken a dive, you stand to lose a lot of money. With investments, you can diversify and not put all your money into volatile securities as time goes on, but with a house you are completely at the mercy of the current market. Make sure your investments are appropriately diversified before trying to pay off the house.