If your mortgage balance is low, does it make sense to just pay it off and be done with it? Of course the answer is very simple. It depends.
From an emotional standpoint, it might feel very good to pay off that mortgage. But is it really a good use of your money? While I think that the emotional component is very important, it certainly should not be the only consideration.
Generally speaking, the best way to make this decision is to look at the rate you currently pay on your mortgage (or the rate you could refinance at), how long you’ll keep the home and the OBJECTIVELY DETERMINED expected rate of return of the alternative investment – in this case, we’ll use the stock market.
For example. Let’s say you have a 5% home loan. You can refinance at 4%, you plan to stay in the home for another 10 years and you expect the stock market to drop faster than a meteor. In this case, the first thing you should do is STOP.
Sorry. It doesn’t matter what YOU expect the stock market to do. It matters what the OBJECTIVELY DETERMINED return might be over the next 10 years. (Of course, this supposes that you use an intelligent investment strategy.)
I understand that it is impossible to know what the market is going to return over the next 10 years. Most pundits plug in 7% as a reasonable market return and I think that is acceptable. Of course the past is no guarantee of the future. But this is a very reasonable expectation.
Back to our example.
Let’s not consider tax consequences for this illustration as it could get very sticky. (Obviously you should consult your tax adviser before making any decision such as this.) In this case, the smart financial move is to keep your investments intact – keep the mortgage and the mutual funds. In other words, this person should not sell off their mutual funds and use the proceeds to pay down the mortgage. By doing this, they have the added benefit of keeping your assets diversified.
OK. Simple decision….right? Wrong. It doesn’t end there.
Let’s say you can’t sleep at night because you are so petrified about the market. In that case, there is a stronger case for paying off the mortgage. There is more to life than money.
I can understand going that route but understand that this approach has it’s problems as well. If you blindly give in to your fear today, what’s going to happen tomorrow? If the market takes off like a rocket are you going to refi, pull equity out of your home and put it back into the market? My experience is that once you open the door to allowing your emotions to take over, it’s hard to put your intellect back in the driver’s seat.
Again, I do not believe that financial decisions can be made without considering your emotions, but I think we have to be careful and tread lightly.
Fear is something many of us are powerless over. The sooner we accept that, the better. It is a driving force in many parts of our lives. Fear can be a very good thing. It can keep us alive. But it can also kill off the most “alive” aspects of who we really are and it can muffle the only thing that sets us apart from the ants – our intellect.
If you’ve made the decision to pay off your loan, do you know how to do it? If not, read my post, “How to pay off your home mortgage early.”
Let me know what you think about this question. I might not be the genius I think I am. Have you considered paying off your home mortgage early? If you did it, why? If you didn’t, why not?
richlor says
February 6, 2009 at 8:36 AMI recently refied – i had a 6.25% loan and dropped to 4.75…My main concern was my monthly payment. I am paying $500 a month less. That monthly payment was and is a concern. I believe my house will appreciate and I hope to stay at least 5 years if not much more. Now I have a tenable payment that will not put me in the poor house…I hope! My “payback” on the loan is about a year but am not so much concerned with that as reducing monthly payments.
Neal Frankle says
February 5, 2009 at 11:49 PMAbsolutely. I would look at the costs of the loan to determine how long it would take to pay for itself. In other words, say you owe $300k and you can shave 1% off the rate. That saves you $3000 annually in interest costs. So if the cost of making the loan is $3000, it pays for itself in 12 months. I’d want to know what the costs are but assuming they are in line, I’d go for it.
Good question. Thanks
mcravets says
February 5, 2009 at 6:28 PMHow about refinancing to shorten the time to payoff? I have 24.5 years left on a 30-year fixed, 5.75% mortgage. Suppose rates have lowered enough that I could have the same payment, but knock off 5-10 years? Would that be a wise move?