I have had a couple of experiences recently that has got me thinking about the various reasons why someone shouldn't make extra payments towards their mortgage.
The first experience occurred a few months ago. A gentleman came into my office trying to get me to sign up to be a vendor for their software which helped people pay their mortgages off early. The basic idea behind this man's product was that somebody will save a ton of money in interest if they put their entire pay check towards the mortgage at the beginning of the month and then use an equity line of credit for monthly expenses. The software (which cost $3,500 by the way) also would tell the client exactly when and how much to add in additional principal payments to the mortgage for optimum savings in interest.
I do not doubt that this strategy works. In fact, it's quite simple to see that this would save somebody thousands of dollars of interest over the life of the loan, which could be a very short amount of time if somebody puts their entire paycheck towards the mortgage. However...
With this salesman, I was initially very impressed with his product and I thought that it would appeal to many people. Saving thousands of dollars in interest on your mortgage would be a big benefit. My second thought was about the opportunity cost of putting that money somewhere else.
The fact is that mortgage debt is the cheapest debt that you will ever have. And with mortgage interest being tax deductible, it's as if the government is subsidizing a 3rd of your mortgage payments (assuming you are in the 33% tax bracket). An interest rate of 6% (rates are much lower than this today) is really more like 4% with the tax deduction.
In 1979 the Dow Jones was at 907.74. As of September 29th, 2009, the Dow Jones is at 9,744. That is an average of 8% a year over the last 30 years. This is including the recent crash in the stock market. Assuming this rate of return continues for the next 30 years, it makes much more sense to fund your retirement than to pay off your mortgage early.
The other experience I had was just yesterday. I was meeting with a client about a refinance. She informed me that she wanted to refinance to a lower interest rate so that she could pay the mortgage off earlier. When I pulled her credit report I noticed that she had about $7,000 in credit card debt on which she told me she was paying an average of 22%.
With this client it was fairly easy to see that it makes much more sense to pay off her credit card debt at 22% interest rather than pay off her mortgage at 5% interest. She agreed and we set some goals for her to do that.
I know that there are some who disagree with me and I can see the merit of the argument that you can't put a price on peace of mind and paying off your house early = peace of mind. Still, in my opinion, if you have disposable income it makes more sense and cents to pay off any other debts first and then apply your disposable income to a ROTH IRA, where you can invest it in just about anything.
In my next blog post I will show you specific examples of how it may be smarter to invest your disposable income rather than put it towards your mortgage.
About the Author
John Neil is a loan officer that is passionate about his profession. His goal with every transaction is to make a customer for life. The result is that 95% of his business comes from referrals of satisfied clients. If you need a cache valley mortgage, you can contact John at 435-770-2709. You can also follow him on twitter @LoganUTMortgage or facebook @facebook/MortgageNerd
