For most homeowners, their mortgage is the biggest single debt hanging over their heads. A lot of people can't wait to live mortgage-free, making additional payments and even using savings to pay off the loan entirely.
However, keeping your mortgage for the full 15 or 30 years might not be such a bad thing. It may actually make a lot more sense to your long-term financial plan to put your extra cash to work elsewhere. Keeping a mortgage allows you to take full advantage of the low interest rate environment, as well as the concept of leveraging your investment dollars, while maintaining the financial flexibility to deal with whatever life throws at you.
Consider these three principals before deciding to accelerate your mortgage payoff.
Low interest rates
Even though mortgage interest rates have risen from their all-time lows; they are still at some of the lowest rates in history. So, instead of using your extra cash to pay down your mortgage early, you can do better in the long run by putting you money to work elsewhere.
Let's say you want to buy a $250,000 house, and that you have that amount in savings. Why not simply buy the house in cash and be done with it?
Well, if you put 20% down ($50,000) and finance the other $200,000 with a 4.25% interest 30-year mortgage, you can expect monthly payments of about $984 per month. So, over the 30-year life of the loan, you'll end up paying nearly $355,000 to pay for the $200,000 mortgage.
However, in the meantime your $200,000 is free to be invested for your benefit. The S&P 500 has averaged a total annual return of about 9.4% since 1929, and $200,000 invested at that rate of return would be worth about $3 million after 30 years.
So, it makes sense to take advantage of the low interest rates being offered on mortgages right now. By saving your money instead of paying for your home in full, it could literally mean millions to your retirement savings.
Use leverage to your advantage
Buying a home with 20% down is essentially using your credit to invest in your home's value at four-to-one leverage. That is, for every dollar you put down, you are buying $5.00 worth of house.
So, if the value of your home appreciates by 4% per year, which is a pretty conservative estimate on a historical basis, you are actually getting a much better return on your initial investment (your down payment).
If you put $50,000 down on a $250,000 home, a 4% annual rise in value would mean a $10,000 increase the first year, or a 20% gain on your original investment.
Flexibility and security
Finally, consider the peace of mind you could gain if instead of putting your extra cash into your mortgage, you used it to build up your savings.
As a rule of thumb, you should aim for six months of expenses in a readily accessible account. Until you have that, you shouldn't pay more than you need to on your mortgage, regardless of what you think of the other reasons I mentioned.
Choosing to finance your home instead of paying it down quickly provides an opportunity to build up savings and take better advantage of long-term investment opportunities, while also putting the awesome power of leverage to work for you. In today's low interest rate environment, it pays to borrow in order to buy your home.
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