Should you pay off your home mortgage early?

Overview
This is a question that many home owners ask themselves – “Should I apply additional funds toward paying off my home mortgage early or invest this money elsewhere?” There is no universal answer. You should consult a financial advisor who knows your situation before making this choice. However, my intent is to help you consider various factors involved with this decision. This topic will be covered over more than one article in order to provide the depth needed.

Do you have other debts?
If you have other debts, then it may make better sense to apply the extra funds toward paying those debts off first. I wrote a three part series that give insights into what credit card debts really cost you and strategies to remove all of your debts. You can read the first article in the series by clicking here.

Consider the opportunity cost of paying your mortgage off sooner
The opportunity cost of money simply means the difference between the rate off return you could earn by investing in something else verses using the funds to pay down your mortgage. Since money used to pay down your mortgage reduces the principle balance of the loan, you are saving the mortgage interest that would have been paid on the extra amount applied toward paying down the loan balance. In other words, if you have a 6% annual interest rate on your mortgage, then applying an extra $100 toward your loan payment would save paying 6% against that $100 or $6 over a year. Now assume you could have invested that $100 in a fund that paid 8% annually, then you could have earned 8% of $100 or $8 over a year. Since you could have earned $8 and only saved $6 by paying down your mortgage, the opportunity loss is the difference between the two or $2 annually ($8 you could have earned - $6 you saved on mortgage interest).

Consider the mortgage interest deduction
I wrote an article in the past about not buying a house simply for the mortgage deduction (click here to read the article). Bottom line is that you only deduct a portion of the total amount paid yearly on your mortgage according to your state and federal tax bracket. In the article I show how someone in a combined state and federal tax bracket of 40% and who paid $25,000 in mortgage interest would receive a $10,000 benefit ($25,000 x 40%). However, the difference of $15,000 ($25,000 paid on interest - the $10,000 benefit) was paid to the bank with no benefit to you. The lost opportunity cost must be considered for what the $15,000 could have received had it been invested in an investment vehicle that paid a higher rate of return than the interest rate on the mortgage. This becomes an even bigger issue for people with a lower combined state and federal tax bracket.

Assume someone has a combined state and federal tax rate of 30%. The benefit then would only be 30% of $25,000 mortgage interest paid, or a $7,500 benefit ($25,000 x 30%). The remaining $17,500 paid to interest ($25,000 - $7,500) must be considered for the associated opportunity loss.

Consider the benefit of reinvesting the tax benefit received
If you have accurately projected your tax exemptions to reduce taxes paid through the year by the $10,000 or $7,500 benefit (based on your tax rate), then the money saved on paying taxes could be invested for an added benefit.

For simplicity, lets just talk about someone in the 40% combined tax bracket that receives the $10,000 benefit yearly. This person increased his or her tax exemptions to reduce the taxes paid from income throughout the year to equal $10,000. If the person receives a monthly paycheck, then the take home pay is increased by $833.33 each month ($10,000 divided by 12 months). This person can now invest $833.33 each month in some investment and receive additional benefit from the associated return.

A secret of the sophisticated accredited investors
Think about this…You paid $25,000 total in mortgage interest over the year and received $10,000 back as a result of tax deductions. In this case, you paid a total of $2,083.33 each month on interest ($25,000 divided by 12 months) of which $833.33 was returned each month to you for investing. Sophisticated investors recognize this double use of the money as part of their investment strategy. However, they don’t do this just with their mortgage, but when structuring all of their investments. Look for ways of getting multiple benefits from the same dollar.

Next article
The next article will continue this discussion. Stay tuned.

Copyright 2009 Ole Cram, President of Marcobe Investments, Inc.
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Marcobe Investments, Inc., is a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration. We are not licensed to sell any interest in a project, nor are we registered advisors.

Disclaimer: This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision.

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