Wednesday, January 28, 2009

Pay off your mortgage? Look at more than just numbers

In financial planning, the first answer to most questions is, “It depends.” And as frustrating as it is for folks to hear, it’s the truest initial answer for most situations. It’s not the final answer—ultimately there is a "Yes" or "No" that makes sense for the individual. But when it comes to money questions, there's usually a lot more gray in the answers than black-and-white. And much of that gray is created by an individual's financial spirit, as well as situation.

Logic versus spirit
For example, you might come to me for advice and ask, “Should I pay off my mortgage?” Personally, I'd like to be able to spend money on something else other than a mortgage payment and have the security of a paid-off home. I’m willing to forego other things in the near-term, such as replacing an out-of-fashion suit for work or enjoying a night out with my wife, to pay additional principal on the mortgage balance each month.

But we’re not talking about me, we’re talking about you. You go on to tell me that your mortgage has a fairly low interest rate of 6%. Wouldn’t it make sense, you ask, to pay the minimum amount of principal on the mortgage each month, and use any additional money to invest in the stock market, which over the long term has grown on average 10% per year?

At face value, your question is financial and logical: If you borrow money at 6% and invest it at 10%, aren’t you making 4%? On a deeper level, though, it’s spiritual: Should you pay off cheap debt when you can conceivably make more money over the long run by investing it?

Align your strategy and goals
Naturally, my initial answer would be, "It depends." But it doesn't depend on whether stocks will earn more than your 6% interest rate, which may be what you want me to focus on. It depends on why you're asking the question in the first place.

For example, you might want a wealthier lifestyle in retirement that requires you to save a substantial amount between now and then. In that case, directing extra money to the stock mutual funds in your 401(k) plan or IRA can make sense. Or being completely debt-free might be extremely important to you, in which case paying extra on the mortgage would be a good approach.

Stop thinking the right answer has to do with just numbers, where the stock market is going or not going. The right answer is the one that best aligns your strategy with your goals and values--essentially, your financial spirit. Get in the habit of answering questions that way, and you'll improve the odds of having financial success.

But really, just pay it off
In actuality, the answer to the money aspect of mortgage question is fairly black-and-white: Pay it off. Financially speaking, the amount you could gain from the excess return of investing in stocks doesn’t justify the high risk, when compared with the certainty of having a paid-off home.

If you’re making good progress on other financial goals, like retirement or college savings, and still have money left over, paying down your mortgage is a smart choice. The real question to ask yourself is, do you think it’s smart, given what you're trying to achieve?

15 comments:

Bret Frohlich said...

This is a great post and you hit the nail right on the head.

The reason I'm paying off my mortgage early isn't because I think I will do better than the stock market.

I do it because I have a goal of leaving the corporate world to start a business or retire early. This is easier without a mortgage.

The financial goal is the driving force, not the interest rate.

SimplyForties said...

Additionally, there is no guarantee of a steady rate of return in any investment vehicle. Pay off your mortgage and then, when your home is secure, gamble with your investments.

Jason @ MyMoneyMinute said...

I agree with Bret - hit it right on the head. It's not ALL about the numbers. Those numbers are a reflection of you and intertwined with who you are.

Most times it's a better decision to have reduced risk of less $$ per month being shelled out in minimum payments, and not leveraging something like your home just to try and make a couple percent gain on an investment!

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QUALITY STOCKS UNDER FOUR DOLLARS said...

Paying off a mortgage can sometimes be worth while.

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