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When stocks start jumping hundreds of points in either direction on a regular basis, you might feel like you'd be more comfortable with a guaranteed return. That's the primary motivation behind an increasing trend among ordinary investors: paying down your mortgage earlier than you have to.
Mad as hell and not gonna take it anymore
The increasing popularity of paying down mortgage debt shows just how far the housing market has come in the past 10 years. Before the housing market bubble burst, many borrowers scrambled to take out as much debt as they possibly could. When their home prices rose, they often returned to their banks to refinance and take cash out. As long as their homes continued to gain value, homeowners did all they could to live up to their new-found means.
Now, though, behavior among homeowners has taken a 180-degree turn. For many, the threat of losing their homes due to excessive debt looms large, even with the "robo-signing" scandal forcing Bank of America (NYSE: BAC ) and JPMorgan Chase (NYSE: JPM ) to halt foreclosures last month. Despite record-low mortgage rates that in the past would have encouraged homeowners even further, the lack of home equity and increasingly tough standards to get mortgages have many people nervous about financing their homes.
Given all these prospective hassles, along with ridiculous moves that Wells Fargo (NYSE: WFC ) and Deutsche Bank (NYSE: DB ) have taken with mortgages, many homeowners have clearly had it with mortgage debt. That makes paying down your mortgage balance look more attractive than ever.
Best of a bad lot
In addition, homeowners don't have a lot of great alternatives for their money right now. Having a substantial amount of cash in a savings account earning 1% or less doesn't make much sense if you can effectively earn 4% or more by paying down your mortgage debt. Even long-term bonds are paying less than many outstanding mortgages right now, especially if you haven't refinanced your home loan in some time.
That's not to say there aren't any alternatives. Better yields are available from the stock market. Dozens of stocks have dividend yields that beat current mortgage rates. And while mortgage REITs Annaly Capital (NYSE: NLY ) and Hatteras Financial (NYSE: HTS ) may leave you more exposed to potentially rising interest rates than you'd like, you'll find that even blue-chip Merck (NYSE: MRK ) , with its 100-plus year history of doing business, pays a yield above 4%.
The benefit that paying down your mortgage has that stocks don't have is certainty. You know that you'll save whatever rate you're paying on your home loan by paying it down early. In contrast, stocks might go up, down, or sideways, and even though those dividend payments will help cushion any drop, you could effectively be putting your home at risk by speculating with unnecessary mortgage debt.
But one downside to paying your home loan early is that it can be tricky to get access back to the money you use to make extra payments. So even if you can afford to pay down your mortgage now, tapping that extra equity in the event of a future emergency may require some additional steps, such as opening a home equity line of credit.
Making the right decision
From a long-term view, paying down mortgage debt when rates are around 4% doesn't seem like the optimal move. If you believe that stocks will revert to their long-term average return of around 9% to 10%, then accepting less than half that return has a huge opportunity cost.
What you get in exchange, however, is the peace of mind that at least when it comes to the roof over your head, you're in control of your own financial destiny. What value that has depends on your own particular views, but for many, it's priceless.
So in deciding whether to pay down your mortgage, weigh all the factors together. Financial considerations like adequate emergency savings and your investment temperament are important to include, but don't underemphasize the psychological factors involved. Even if a decision may not give you the best return on paper, it still might be the best thing for you to do.
Are you paying off your mortgage early? Chime in by leaving a comment below!
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.