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With the financial markets as volatile as they've been lately, everyone's looking for a sure thing. Increasingly, savvy homeowners think they've found it, and the latest trend has them putting more of their spare cash toward what once would have been an unheard-of "investment": getting their mortgages paid off faster.
A world turned upside down
It says a lot about the investing environment we're in that even with mortgage rates at record lows, people are seriously considering ways to pay down their mortgage debt faster. In the past, when interest rates fell, most homeowners rushed to refinance in ways that pulled out additional equity and made the most of interest savings over the long haul.
Instead, as an article in The Wall Street Journal over the weekend observed, homeowners are interested in getting their mortgage debt paid off faster. Nearly one in three borrowers who refinanced their mortgages during the first quarter replaced a 30-year fixed mortgage with a shorter-term loan. In addition, 15-year mortgages have gained in popularity even outside of the context of refinancing.
Part of the appeal comes from a particularly wide spread between rates on 30-year mortgages versus 15-year loans. At 2.83% for 15-years versus 3.53% for 30-years, the spread is the widest it's been in the 20 years or so that government mortgage-tracker Freddie Mac has kept records.
But those lower rates come with a catch. In order to pay your loan off in 15 years versus 30, your monthly payments must be significantly larger. For a $200,000 loan at the rates mentioned above, payments on a 30-year would be just over $900, while a 15-year would require payments of almost $1,365 per month.
The key, though, is that all of the extra $465 is going toward repaying principal. So it's not as though you're actually losing that cash; it's going toward building up equity. In addition, you'll pay almost $1,500 less in interest during the first year of your mortgage, with that extra $1,500 also going toward paying down principal.
A smart investment?
Getting out of debt definitely has appeal for many people right now. But with mortgage rates as low as they are, should you be in any rush to get your mortgage paid down any faster than you have to?
The answer depends on what you would do with the money. For those who have money stuck in savings accounts or money market mutual funds earning almost no interest, the chance to earn essentially 3% in interest by paying down a mortgage early makes some sense.
But if you're willing to take the risk of putting that money into the stock market rather than using it to pay down mortgage debt, it's a much closer call. By keeping your mortgage higher, you'll pay that roughly 3% in interest, but for many people, the interest is tax deductible. As a result, you'd only need to find investments that return 3% or more in order to end up ahead.
Dividend investors will point out that it's relatively easy to get yields of more than 3% from a wide variety of dividend-paying stocks. Although the irony of taking money you'd use to pay down your mortgage and investing it in mortgage REITs Annaly Capital (NYSE: NLY ) or American Capital Agency (Nasdaq: AGNC ) may seem attractive, you don't need to stretch for double-digit rates to meet a 3% bogey. You can even choose from a number of blue chip Dow component stocks, with pharma giant Merck (NYSE: MRK ) and telecom rivals AT&T (NYSE: T ) and Verizon (NYSE: VZ ) among the least volatile from a shareholder perspective.
Just remember that using money to invest in dividend stocks rather than paying down a mortgage isn't a sure thing. While the dividend cash flow may help you make your monthly payments, you still have the risk that the stock price will go down, leaving you behind on the deal.
Leaving aside the pure numerical arguments, though, it's refreshing to see people taking responsibility for their finances more prudently. As useful as leverage can be, using it unnecessarily adds risk to your financial situation. If that trend continues, then the average household should find itself much more financially stable in the years to come.
All that said, you still need to invest some of your money toward your other financial goals. Find out some great stock names to consider for your portfolio by accepting this free invitation to read the Fool's special report on long-term investing. Inside, you'll learn about three stocks to help you retire rich. Get your free copy today while it lasts!