Brad Tinnon

Brad Tinnon

Should You Pay Off Your Mortgage Early? Part II

Last week in Part I of Should You Pay Off Your Mortgage Early, I discussed one of the most important reasons why it’s usually bad advice to pay off your mortgage early. In today’s blog post I will go over the remaining three reasons.

LOSS OF CONTROL

Maintaining control of your money is often an overlooked, yet very important benefit. We see people all the time who have been sold an investment product that they can’t get out of without paying thousands of dollars in penalty fees. In other words, their money is not liquid and they can’t do with it as they please. A similar scenario could unfold when you pay extra toward your mortgage.

If you find yourself without a job or with lower income, the bank will most likely not allow you to take out your own equity, because you won’t have an ability to repay it.

This brings up a couple of concerns.

First, you worked really hard to pay off your mortgage and now the bank won’t let you touch it. And second, even if you could get to the equity, the bank is going to charge you for it. To make matters worse, it’s not a good idea to go into debt if you do lose your job or income. Wouldn’t it be better to maintain control of your money and not pay it to the bank faster than it has to be? Then, if you find yourself in a situation where you need the money, you will have it and not have to pay for it.

By the way, when you repay your loan early, the bank is using your money and investing it.  This is why they want you to pay more toward your loan.  They make you think it’s in your best interest, but in fact it’s usually in their best interest.

LACK OF DIVERSIFICATION

Many people think that their home is an investment, but it really shouldn’t be treated this way. According to Robert Shiller, an economist at Yale and creator of the closely followed Case-Shiller Index on housing prices, residential housing is a disappointing investment. Based on his data, he states that from 1915 to 2015, U.S. home prices rose only 0.6% per year. If you sat down and calculated all the time, energy, and maintenance you’ve put into a home, you may discover that it’s not as great of an investment as you thought. And for those reasons renting ends up being the better investment for many people.

So, if homes typically aren’t a great investment, why do people feel the need to aggressively pay them off as if they are making a good investment? By paying extra toward your home, you are essentially “investing” in one asset (your home) within one asset class (real estate). This is not proper diversification and carries a great deal of risk. A better approach would likely be to use your cash flow to invest into multiple investments rather than plowing it all into your home. That way you significantly reduce the odds that one investment (i.e. your house) wipes out your entire savings. Additionally, if your home depreciates, then you may have very little if any equity (i.e. return), even though you’ve been faithful making extra payments.

SHORTFALL IN OTHER GOALS

Two major goals that many people have are to plan for retirement and save for their children’s college education. And often times, one or both of these are underfunded. If you aren’t on track to meet these goals or perhaps another goal altogether, then funds you were planning on using to pay off the mortgage early would likely be better served funding your goals. For most people there’s only so much discretionary income each month so you must decide if paying off the mortgage early is worth sacrificing other goals you may have. In other words, you must determine the priority of your goals.

I hope that you’ve enjoyed this two-part series. The next time that you hear someone tell you to pay off your mortgage early because you’ll save thousands in interest, you’ll know that there’s more to the story.

Obviously there is no one-size-fits-all approach, so stay tuned for next week’s blog post where I will discuss situations when it might make sense to pay off your mortgage early.

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Brad E.S. Tinnon
CERTIFIED FINANCIAL PLANNER™
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