Many people hate their mortgage because they know over the life of a 30 year loan they will spend more in interest than the house cost them in the first place. To save money it becomes very tempting to make a bigger down payment, or make extra principal payments. Unfortunately, saving money is not the same as making money. Or, put another way, paying off debt is not the same as accumulating assets. By tackling the mortgage payoff first, and the savings goal second, many fail to consider the important role a mortgage plays in our savings effort. Every dollar we give the bank is a dollar we did not invest. While paying off the mortgage saves us interest, it denies us the opportunity to earn interest with that money. Consider this investment: Every dollar you invest is inaccessible. Every dollar you invest has the potential to increase your federal and state tax bills. Every dollar you invest is guaranteed to earn a very low rate of return for the next 30 years. Every dollar you invest makes the investment less safe. Not too many of us would jump at the chance to make this investment, yet millions do every year by pre-paying their tax-deductible 30 year mortgage loan. Remember, the only way to get your equity out is to borrow it back on the bank’s terms, at some unknown rate in the future or, worse yet, sell the house. By pre-paying your tax deductible mortgage you increase your tax bill each year as you have less interest to deduct. The after-tax rate on a 30 year fixed mortgage is often much lower than many conservative investments. The more equity you build up in your home the more risk you take. If you had a disability or job loss, and had to stop making payments on a 100k loan on a 400k home, the bank could still foreclose and you would be out 300k. If you stopped making payments on a 350k loan you would be out only 50k. The same holds true if the home is underinsured or their is a natural disaster, like a flood, that the house is not insured for at all. Most of us think that the more equity we have in our house the safer we are. The truth is that the more savings we have, not equity, the safer we are. Before paying down your tax-deductible mortgage, make sure you have the following financial milestones accomplished:
- Cash Cushion – Build and maintain a cash cushion with 3 to 6 months of liquid living expenses.
- Protection – Establish appropriate levels of disability and life insurance.
- ‘Non Preferred’ Debt Free – Pay off all non-tax-deductible debt (credit cards, installment loans, etc).
- Retirement and College – Plans fully funded.
It is important to realize our financial goals in the correct order. Paying off your mortgage is a great goal. However, it should not be your first, or only, financial goal.