To Pay Down or Not Pay Down Your Mortgage
The New York Times had a good primer this weekend on when it makes sense to send in money above and beyond your required monthly payment to reduce the principal amount of your mortgage. Back in corporate finance class in business school (if we recall correctly—it’s been twelve years!), you’re taught that a company should…
The New York Times had a good primer this weekend on when it makes sense to send in money above and beyond your required monthly payment to reduce the principal amount of your mortgage. Back in corporate finance class in business school (if we recall correctly—it’s been twelve years!), you’re taught that a company should pay down its debt if can’t find any alternative use for its capital that it believes can return as much as it’s paying in interest on its debt. The same thing applies to an individual, and with rates as low as they are and the significant tax breaks factored in, the hurdle is pretty low right now. “Back when rates ran at 7 or 8 percent, making extra payments offered what amounted to a guaranteed return on your money,” says The Times. “When you’re ridding yourself of debt that costs you much less, however, it’s easier to imagine a future when you could more easily earn a higher return by investing those potential extra mortgage payments someplace else.” Of course, there are some other common-sense considerations to factor in, like the flexibility and safety that having some cash sitting in the bank can bring or the priority of paying off higher-interest debt like credit cards before attacking the balance of your mortgage.
When Not to Pay Down a Mortgage [Brownstoner]
i think these kinds of articles do more harm than good.
this is the equivalent of writing an article about lighting matches in the forest and saying “do what feels comfortable”.
unfortunately these kinds of things always come down to miscalculated risk – not reward. not just personal tolerance. People can tolerate way too much until they realize they had no idea what they were thinking. You probably shouldn’t feel “safe” until your total debt is under 2x your salary (incl rental income), and LTV 50%. And you should have at least a year of emergency cash. pay it down to that point and then you can breathe.
if you are all floating (apparently a good bunch are), have you done a sensitivity analysis of a 10% mortgage? i don’t believe the article even touches on such common sense stuff. did you do a 5-10 year sensitized cash flow? we just went through a massive money pump. could your salary go up 5x if rates go through the roof? probably not! then what the heck are you doing?
factoring in an “adjusted” or after tax interest rate does nothing for you when you lose your job – because it goes away. it will be a higher volatility hit if you lose your income. it is a really dumb way for the average joe to even think about calculating if they should pay down their mortgage.
i wish the new york times wasn’t all so caught up in trying to make pretty sounds on paper rather than write an article of substance.
Pay it down. We’re falling off a cliff and into a deflationary spiral where, literally, cash under a mattress earns interest as the value of the dollar goes up. The capital markets are going to crash through the government-induced March lows.
It’d be even better to just sell your house before it’s paper value falls in half or worse. If you have no equity (aka “underwater”), it’d be better to just “walk away” as did Tishman-Speyer/Blackrock (but consult with an attorney beforehand to strategize against a possible deficiency judgement).
Cash is King right now but only if coupled with minimal debt.
***Bid half off peak comps***
I too am struggling with this.
The rate I have for my 30 yr fixed at my coop is 5.875. I’ve been paying for a little over 3 years now, and refinancing does not seem to be an attractive option, as I’ve paid mainly interest in the first few tears. I pay an extra $5000 every March. I guess the plan would be to do this until the payments made are at least 50% principal and then only pay it off according to the schedule?
@ wellheythere: I suspect dibs agress with you that you should expect a return on the S&P above 7%. I think the high end of your 7-11% rage is a reasonable assumption going forward.
On another note, I certainly understand folks that say things like “the security of knowing that your mortgage was paid off has an attractiveness all of its own”. But having more $$ (i.e. not pre-paying when it makes no real sense) and making the right financial decisions also has an attractiveness all its own…
It’s also worth noting the distinction that can arise between paying down and paying off a mortgage. I paid down a chunk of my mortgage a while back without realizing that it would not affect my monthly nut — that would only reset when the rate reset for the first time (it was a 5/1 ARM). I was doubly kicking myself because the credit crunch meant that I couldn’t refinance because I’m an independent contractor with an uneven income flow (and this despite the fact that, even considering the market drop, I was financing only about 1/3 of the value of the property — I’m very conservative). So when some Good Financial Things happened, I paid the damn thing off, and it’s a weight off my mind. I wasn’t going to gamble that I could do better in the stock market, particularly because, with these uneven income flows, I might have had to sell on short notice to deal with current cash-flow issues.
So, with that overlong lead-in, my suggestion would be 1) consider whether a pay-down reduces your payment or not (and whether you care), and 2) if you can pay off the mortgage, particularly if it’s above-market, it may well make sense to do so.
Single family/condo/co-op I think I would try to pay it down early. Multi-family? I’m keeping it as is. It’s a built in deduction and once it’s gone my tax rate is going to skyrocket.
when stk mkt is fine, paying off low interest debt is stupid. but when you encounter a spanking like this recession, one thinks twice about that logic. if one is in AMT status on tax return, one realizes a good chunk of the mortgage interest is really not deductible.
right or wrong, it does feel great to have paid off the mortgage early cause peace of mind is priceless
Nothing is guaranteed in the stock market.
That said, 6-7% has been a pretty good baseline historicall to work off of for the S&P. Of course, that assumes that you are invested in the S&P 500 index (via fund or etf) and aren’t getting nailed on taxes or transaction charges.
Dave, can you explain what you mean about the S&P? I’ve been taught that it was sacred truth that the S&P will earn (or rather, has always earned) 7-11% annually if you have a long enough time frame, but I’m always curious to learn dissenting arguments.