When Paying Off Doesn't Pay

http://finance.yahoo.com/expert/article/yourlife/37252 ^ | Friday, June 22, 2007, 12:00AM | Ben Stein

[BenLurkin]

Plus ... you do have to have a place to live.

[AmericaUnited]

That is, if you have a mortgage with 6.5 percent interest, you'd earn roughly 6.5 percent by paying it off early.

Actually it's worse than that for most people because that interest is tax deductible. So you're getting more like a 4% return. NOT THAT GREAT!

[JamesP81]

Most folks, if they didn’t have a monthly mortgage payment, would be much more liquid than they are now. And besides, while you still owe the bank money it’s not really your home anyway.

[CSM]

Another way to measure one’s risk tolerance in this scenario is to ask, “if your home were paid off, would you take out a mortgage to invest that money in stocks?”

Personally, I prefer the security of being debt free and I am working hard to get that security. I will eventually have my income working for me, but in the meantime I prefer not to have my debt working for me....

[AmericaUnited]

Plus ... you do have to have a place to live.

Paying off your mortgage and selling your home are two entirely different things.

[BenLurkin]

Except there is no point in paying interest to the bank just in order to get a deduction. There are other ways to shield that money and still keep it. A person paying off their mortgage could turn around and fully fund a 401k plan and thereby reduce his or her tax liability.

[AmericaUnited]

Most folks, if they didn’t have a monthly mortgage payment, would be much more liquid than they are now.

But if they have to use $100,000 or $200,000 of cash to become mortgage free, exactly how does that make them 'more liquid'?

[BenLurkin]

If you pay off your mortgage it is going to be easier to keep your home.

[BenLurkin]

“if your home were paid off, would you take out a mortgage to invest that money in stocks?”

Exactly!

[AmericaUnited]

A person paying off their mortgage

The typical after-tax 'cost' of a mortgage today is something like 4%. If someone had several hundred thousand dollars of cash to pay off their mortgage, it would be better for them to just put that money in something like a 401K. Once it's parked into "the house", you don't have access to it.

[AmericaUnited]

If you pay off your mortgage it is going to be easier to keep your home.

Not really. If your mortgage was $200,000, and you kept that amount of money in liquid assets, you could always use it to make mortgage and property tax payments. If you had no money and no mortgage, you could lose the house by not paying property taxes. Cash is king!

[AmericaUnited]

Cash flow is king.

[CSM]

By putting all of my effort towards becoming debt free, I will have a paid off house and will be able to heavily invest towards retirement. I estimated the difference between that plan and doing the normal 15% retirement savings and normal monthly mortgage payment.

The final difference between the two is approximately $33K less in a retirement fund, but a savings of $75K in mortgage interest. I think that $33K buying security for me in my retirement years is well worth the investment.

[JamesP81]

Personally, I prefer the security of being debt free

If you owe money on your house, it's not really yours. I'm in agreement with you.

[JamesP81]

Not really. If your mortgage was $200,000, and you kept that amount of money in liquid assets, you could always use it to make mortgage and property tax payments. If you had no money and no mortgage, you could lose the house by not paying property taxes. Cash is king!

Well, OK, that's simple: you wait until you have $220k in assets then pay it off. This is assuming, of course, that you have no other income.

[CSM]

Yep, with a mortgage you are one extended medical issue away from being homeless....

[AmericaUnited]

you wait until you have $220k in assets then pay it off.

And then pay it off with what?

[AmericaUnited]

Yep, with a mortgage you are one extended medical issue away from being homeless....

Quiz.. Who will be homeless first, the person with a $250,000 mortgage and $250,000 of cash in the bank, OR, the person with no mortgage and no cash in the bank? If you are sick or unemployed, you have to go begging to some bank to get your cash back out of the house to help pay for your illness.

[Mr. Jeeves]

Personally, I prefer the security of being debt free and I am working hard to get that security.

So do I. There is way too much "good debt" propaganda being circulated by those who stand to profit from it.

[JamesP81]

Your post postulated the mortage was $200k, and that you had that amount in liquid assets. If paying the taxes were a problem, simply wait until your liquid assets were $220k or so, then use $200k of that to pay off the mortgage. You’ll $20k of padding left over for things like taxes for that year (I can’t imagine that taxes would be 20,000 dollars on any reasonably sized house).