Is Paying off My Mortgage a Wise Idea?
Almost daily, I am asked by one of my clients about whether they should make additional principal reductions to pay off their mortgage more quickly. Conventional wisdom and popular financial advisors tell us we should absolutely work to eliminate the mortgage and not have that payment. I do not agree with their methodology.
Before you get upset with me, let me explain why. According to Bankapedia.com, the average length of a mortgage loan before someone pays it off or refinances is 7 years! In my own mortgage practice, my average client holds his mortgage for 3-5 years before either refinancing or selling their homes. In act, I’ve worked with clients who have had 4 mortgages on the same house in the last 7 years due to the falling interest rate environment. When I ask my clients how many homes they’ve had in the last 15 years, many will tell me they’ve had at least 2 and in many cases 3 or 4.
My point is simple. Many of the same clients do not have any savings or are living on very tight budgets. They’ve been convinced that making an additional principal reduction will save them interest over the life of the loan and build equity. If they sell or refinance their mortgage in a few years, that additional principal payment didn’t help pay the loan off.
Principle Reductions Do Not Increase Equity
Consider this. When you transfer cash to pay down a mortgage loan, you are transferring an asset to reduce a liability. The bankers have done a great job of convincing us that it saves us interest and it increases equity. First let’s address the Equity portion.
Cash value of cash is always 100% of it’s value. When you transfer your $1 to pay down a mortgage a couple of things happen. You’re giving your money to the lender. The Lender is not paying you any interest for holding your hard earned cash. The lender is not advancing payments or recalculating interest owed on your loan. In the event that you ever need your cash or principle back for an emergency or for an investment, the lender will charge you fees to access your money IF you qualify. Those fees immediately reduce the 100% value of your $1 to somewhere around $0.97. You lost Value in the asset column of your balance sheet.
There is another way to access your cash. You can completely liquidate your home or sell it. That will cost you approximately 8% in costs. Your $1 is now reduced to $0.92.
In addition to that, if you took your $1 and saved it outside the lender’s grips, you could earn interest on it. Let’s say you earn 1% interest on your dollar. You will have $1.10 dollars. That cash is liquid meaning you can access it in an emergency. If you loose an income source, you have access to your equity without having to pay for it. If you can’t make your mortgage payment due to a job loss or income reducing disability, you will have access to all that principle you’ve been paying to make your mortgage payments and keep your home.
So let’s get this straight. Conventional wisdom says pay extra to pay down a 30 year mortgage that I’m going to refinance or sell in 5-7 years trapping my hard earned dollars in a lender’s account giving me no access and no interest growth. In the mean time, I am also living on a tight budget without proper life insurance, no investments, and no retirement plan. Sounds like a great plan. Unfortunately, Millions of Americans live by this Wise Financial Planning strategy year after year and continue to get poorer while the banks get richer off of untrained and unsuspecting honest working Americans.
Your money better serves you in other ways.
I am a fan of paying off a mortgage, however not the way the banks want us to do it.
I’d love to hear your thoughts about this.
God Bless You!