The following is a post by MPFJ staff writer, Derek Sall. Derek is the owner of the blog, LifeAndMyFinances.com, where he teaches people how to get out of debt, save money, and become wealthy.
Have you ever thought about paying off that mortgage faster than the typical 30 year term?
Is it a smart thing to do? What are the pros and cons of doing so? These are all great questions and should be considered carefully. Let’s dive into each of the positives and negatives of doing so, and then you can make a confident decision of what you want to do.
The Interest Expense
When buying a house, most people put a little bit of money down, but then take out a 30-year loan for the majority of the remaining payment. If your loan percent is 4.5% or so on a $250,000 house, then you can plan on paying an additional $180,000 in interest. That’s right, you will pay a total of $430,000 on your $250,000 home.
This sounds like a great reason to pay the house off early, but many home-owners think that they can earn more than 4.5% by investing their money instead of paying off their loan quickly. So, they decide to keep the loan for its 30 year life, but invest a few hundred bucks in the market each month to build their retirement fund.
While this does make sense, many people don’t actually invest the money that they said they would. Instead, it goes toward a new boat or new car, which depreciates in value and often costs them much more in the long run than if they would have put the money toward their home mortgage. By putting extra money toward the home loan, you are guaranteeing yourself a 4.5% return, which isn’t amazing, but it’s something.
Mortgage Tax Deduction
Many people are advised to keep their mortgage because of its tax incentives. Because you are paying interest on your loan, the government will reduce the taxes that you owe each year.
It sounds all well and good, but this is how it really works. You pay in 4.5% on your home loan each year and because of this, the government will not tax you on this payment, which essentially pays you back 1% or so. In other words, you pay in $5,000 in interest each year to avoid $1,250 in taxes paid in. By doing the math, you are essentially still losing $3,750 on this deal. Do not buy a house and pay the interest just to avoid tax payments. It makes absolutely no sense.
One of the best ways to get wealthy today is to increase your cash flow.
With more cash each month, you have more opportunity for investing and can then increase your overall wealth much faster than your neighbor down the street (who is making payments on everything you see in his yard). To do this effectively though, you basically need to reduce your cash flow to nothing for a few years while paying off your mortgage debts. Many choose to keep their mortgage and stock up their reduced cash flow (after they pay their mortgage) each month. In the end, the difference may be negligible, but I believe that there is much more power in that large cash flow only a few years later when your mortgage payments are gone. Just think of how much cash you would have each month if you no longer had to pay your mortgage!
My Biased Opinion
I’m sure you already know my opinion of whether you should pay off your mortgage or not. Over the last couple of years, I have reduced my consumer debts from $45,000 down to zero, have saved up $15,000 for emergencies, invest over 15% of my income, and am now working to eliminate all of my mortgage debt ($54,000) by the end of this year.
If I can accomplish this, I will owe absolutely nothing to anyone which means I can freely give as much as I want and invest as much as I want – all before the age of 30. With absolutely no payments, do you think I could become wealthy in the next 40 years of my life? Absolutely! And, if you begin working toward debt freedom, I believe that you can soon be wealthy as well.
How about you all? Do you think it’s best to pay off your mortgage as soon as possible, or only pay the minimum required and save the money for later needs?
Share your experiences by commenting below!
***Photo courtesy of http://www.flickr.com/photos/68751915@N05/6808984167/sizes/l/