Pay Off the Mortgage?

It’s a question which has long plagued homeowners, at least those homeowners fortunate enough to have additional funds leftover at the end of a month:  “Should I paydown my mortgage?”

I think the way to approach answering this question starts with another one: “What happens to the money if it is not applied to the mortgage?” If the answer is “I don’t know” or some variant, or if the money disappears down a rabbit hole of unnecessary purchases, then I come squarely down on the side of using those funds to pay down the mortgage.  The rate of return on early payoff of a mortgage is almost always low: namely, the interest rate on the loan minus the rate of tax benefit being sacrificed.  So in today’s environment, the return might be about 3%.  That is not great at all, but it beats bank interest and it beats new clothes with the tags still on hanging in the closet.

It is probably not a bad idea if you are a cautious investor.  If you want to invest in something but are wary of the stock market, real estate, or other investment options, paying down a mortgage is not a bad, extremely low-risk alternative.  The key assumption I am making is that you have no other debt. If there are credit card balances out there, they should get top priority, since they are almost always linked outrageously high rates.

If none of this describes you, and you are comfortable with riskier investments in more promising markets, than paying down a mortgage is not a great idea:  better to use that money for an index fund, a particular stock that seems attractive, or a piece of real estate that will appreciate and/or generate rental income.

I ran some scenarios through UBS investment models on my desktop, and they pretty much nearly always recommend a market investment over a paid-down mortgage.  Still, few things create as much piece of mind as having no debt and owning the roof over your outright.

Tim Shields


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