From Financial Integrity
Paying Off Your Mortgage Early?
Finally collective wisdom is turning back toward the prudent goal of paying off your mortgage and NOT using your home as a wallet. People are learning the hard way that a mortgage is really just a rent-to-own program, where the bank actually owns your home for decades, but you get to live in it. For every dollar not SPENT in mortgage interest, you have the chance to EARN interest on the savings. Check up on your situation and see: with a 30 year mortgage, most of the first 20 years of payments – and at least as much as the house price – is just interest on the debt, probably going to some corporate bank with executives paid $2,800,000 million/year (2008 average.) One way to align your finances with your values is to pay off any debts – including mortgages -- as quickly as possible, and redirect those would-be interest payments to more worthy ends. Many people who’ve gone through all the steps in the FI program live mortgage free!
There are two main ways to pay off a mortgage: saving up the money in an income-generating account and paying off the mortgage in one lump sum; or paying extra principal payments monthly or periodically, thereby shortening your mortgage term. There is a big difference between these two methods, so as in all economic decisions, you will want to consider your financial habits and goals realistically, before making a decision. It’s safer to assume you will NOT be able to just sell your house if you need cash (or assume you will have to sell it for much less than you think it’s worth to get a quick sale.) Remember that you will still have to pay insurance and property taxes, likely as semi-annual or monthly bills.
Align Your Decision With Your Long-Term Goals
Here are some things to consider before sending any checks to the bank. (Add to this list if you can think of others! Go here for instructions on how to edit this page.)
- Do you have 12 months (depending on your other resources, you may want more) worth of living expenses available in cash/cash equivalent, but set aside only for emergencies?
- Do you have good health insurance and money set aside to cover deductibles/co-insurance, or to cover uninsured medical fees in case of accidents? (In case of an accident, you may not be able to refuse expensive emergency services, until you regain the ability to make your wishes known.)
- Might you move in the near future? If so, you may not want to make extra principal payments, as it won’t reduce your interest payments in the short term.
- Do you foresee any large expenses in the future? (Roof repair? Paying for college?)
- U.S. tax-payers: Calculate the tax impact – if you get a tax deduction, chances are you’re paying much more in interest than the value of any tax relief. (Because it is a deduction off your taxable income, NOT a tax credit.) Still, this could change your tax burden, and you may want to change your withholding allowances accordingly.
- Would it be relatively easy for you to get financing if you decided to re-mortgage and remove equity in the future?
- Do you have a line of credit you could draw on if you had an emergency need for cash? These usually charge an annual fee, even if you don’t draw down funds. Also, it can be revoked at any time and probably has a variable interest rate, but using this as a short-term debt solution might be a lot cheaper than a long-term debt instrument like a mortgage.
- Is your house in great condition, where you could rent it out (a room, a “mother-in-law apartment”, or in its entirety) if you needed to use it to generate income? If things get really tight, this is a great alternative rather than signing your house BACK over to the bank with a reverse mortgage.
This is a major decision, so make sure that your plan will really benefit you financially. Also consider the emotional and lifestyle impacts of both tying up your wealth in real estate, and feeling the freedom of actually OWNING your home.
See also Mortgages and life insurance policies for tips on tabulating mortgages in your expense tracking.
Download a File:Mortgage amortization schedule.xls (MS Excel 2007 file) to see what you're paying.