Finance Question

[Big Country]

Just a genera ltheory question on if the below thought process is flawed thinking or not.

 

I have seen several people at various sites suggesting that not paying a mortgage off early (say an extra 100-200 a month) is a good financial decision, not because you can possibly earn a higher rate of return on the money you don't put towards the mortgage, but because by paying it off early you lose the tax deduction from the mortgage interest.

 

IMO, this is flawed thinking, as while yes you do get a tax deduction for the mortgage interest you pay, you are still paying out that money. And, 100% of the money you would have spent on the interest is then taxed at 100%. So, if you can pay off your mortgage 5 or 10 years early (for simplicity, let's assume that the rate of return on any potential savings account that the extra principal only money would go into matches the rate you pay on the loan), that is 5 or 10 years where you can then put not just the interest money, but the entire payment amount into savings, and while 100% of the interest portion was outgoing (even if tax credit completely negated the outflow), you are now ahead of the game because you are not paying that interest anymore, you are increasing your savings amount and taxes are not 100% so that extra interest money that is not taken in taxes goes to your bottom line. (I could be flawed here as your tax amount is based on your income, then the deduction is applied, so I suppose your tax amount is unchanged, but your deductions go down, but at the same rate as your interest payments go into your savings account, and, I am not certain of the amount of mortgage interest that can be applied as a tax deduction.. if less than 100% you come out ahead still)

 

Anyone more in the now able to clear this up for me so I can more logically and factually discuss the matter.

[The Irish Doggy]

The answer from the financial people is a very firm: it depends.

[Atlanta Cracker]

You basically have to do the math on the net money in your pocket.

 

Let's say you have a mortgage rate of 6%, are in the 25% tax bracket and have enough itemized deductions that 100% of the interest is tax deductible. For simplicity sake we'll assume simple interest rather than amortized (with amortized you pay mostly interest the first few years and mostly principal the last few years).

 

Based on the above, the cost to you is 4.5% (6% * (1-.25)). Another way to visualize this is that paying $6,000 in interest on $100,000 would save you $1,500 in taxes - but you still net spending $4,500. So, you would be better off paying down the mortgage if you are getting less than 4.5% on your money.

 

Some would argue that is easy, some would rather not owe money. I say it's personal preference.

 

 

I personally will never have more than 20% equity in a home because the equity is earning exactly zero percent (home appreciation is independant of how much equity you have in it) and I feel very confident that over time I can net an investment return higher than the cost of borrowing against that equity.

[Perchoutofwater]

It really depends on what you are comfortable with. My mortgage is around 5.15%, and I'm fairly young (33), so there is no way that I would pay mine off early. I'd rather invest that extra money. My money manager has been getting me around 20% on investments the last few years, so I would be stupid to pay it off. Now if the market starts heading south, I might re-think my strategy, but as long as the market is going along ok, I'd rather invest that extra money If I was 55 or 60, I'd probably pay it off, because then I wouldn't have as much time to recover from a down turn in the market.

[sundaynfl]

Every time you put an extra $100-200 into your mortgage you are giving up the growth potential that you would see on that money in an investment vehicle. AC hit it on the head, I would prefer having my own "home bank" that I am able to make money in the arbitrage that I am able to perform with my mortgage. I would rather be able to borrow from myself if I ever lost a job or became disabled, than have to try to borrow my equity back! "Here's an extra hundred dollars Mr. Banker and if I ever need it back, I'll come to you to borrow it back on your terms and pay your closing costs... that is if I can qualify for it!"

[polksalet]

Riddle me this, if your house were paid for, would you borrow money against it to invest?

[polksalet]

Ask 10 realtors. Most are honest people so take what the majority of them say and act on it.

[Big Country]

Riddle me this, if your house were paid for, would you borrow money against it to invest?

 

On that note, I was reading an article from I believe a financial planner (one of those types0, and he was relaying how the clients of his that paid off their mortgages early were the ones that were able to retire the earliest.

 

Now, a response posted to that article again brought up the "tax deduction for mortgage interest" as a primary reason for not paying off a mortgage. I think that reason is stupid, but, as noted in my reply, understand the idea of not paying extra towards mortgage if you are fairly certain of making more on your investments than you pay in interest.

[Atlanta Cracker]

On that note, I was reading an article from I believe a financial planner (one of those types0, and he was relaying how the clients of his that paid off their mortgages early were the ones that were able to retire the earliest.

 

I would argue that's because they are dilligent savers and not that paying off the mortgage is necessarily the best strategy. If those same people would have socked that extra money into the S&P 500 over that same period of time they would have their homes paid for AND a ton of money in the bank.

 

 

The real problem is, most people who don't pay down their mortgage don't really save the difference but end up spending it. Heck most people refinance every few years to extract equity and then spend it. That's a losing proposition.

[polksalet]

I would argue that's because they are dilligent savers and not that paying off the mortgage is necessarily the best strategy. If those same people would have socked that extra money into the S&P 500 over that same period of time they would have their homes paid for AND a ton of money in the bank.

The real problem is, most people who don't pay down their mortgage don't really save the difference but end up spending it. Heck most people refinance every few years to extract equity and then spend it. That's a losing proposition.

 

you are wise

[Atlanta Cracker]

Riddle me this, if your house were paid for, would you borrow money against it to invest?

 

 

If I could refinance it and make the payment out of current cash flow so that the equity stayed invested then definately. If I inherited a million dollar mansion and would have to make payments from the equity I took out, then no.

[polksalet]

If I could refinance it and make the payment out of current cash flow so that the equity stayed invested then definately. If I inherited a million dollar mansion and would have to make payments from the equity I took out, then no.

 

I wish I had your guts.