It's a question many people wonder about. Does it make sense to pay it off early? If you’ve ever attended our online class www.NoLoanRealEstate.com you might assume we are strong advocates for leading a 100% Debt Free life (Including Mortgages). I will let you draw your own conclusion at the end of this article.
With very few exceptions, nearly everyone I’ve ever consulted with looks forward to the day when they don't have to write that huge check to the bank every month.
However many argue there might be better uses for your money, especially when mortgage rates are really low.
It’s obvious why the experts can’t agree. As with so many other financial decisions, it really just depends.
Let’s review together some of the factors you should consider when deciding if it makes sense for you and your family:
How much could you save on your mortgage?:
If you’ve ever seen our free online training called “Debt Free For Life (Including Mortgages)” you can plainly see that even with record low interest rates, it’s still possible to prevent as much as 80% of the total interest you would otherwise pay. Yes, you should factor that you can deduct your taxes but for many, especially real estate investors this is a marginal benefit. The reality is that we are SOLD the significance of interest rates by the banks.
Here is an interesting question. If you were offered a loan with a 12% interest rate, would that appeal to you? Probably not. However would you rather pay 12% for 10 months or 4% for 30 years??
People resoundingly agree that the term is just as important as the interest rate; however, we are not encouraged to consider the length of time we will pay on our loans by the banks. Why? Because, over 360 months, they earn exorbitant amounts of interest. Don’t believe me? Go back to that dusty file labeled ‘mortgage stuff’ and pull out your TRUTH IN LENDING STATEMENT. It will remind you just how much that home is truly going to cost you over the long haul. Scary.
Of course, if your rate seems high, you may want to consider refinancing. This calculator can help you determine how long it would take to recover any costs you may pay to get a new mortgage. Keep in mind that even if you WANT to refinance regardless of the perceived benefits, hurdles like poor credit, high loans to value, or high debt to income ratios may prevent you from taking advantage of a better loan. Either way, your money may be better used elsewhere. So what else should you consider.
This subject is always an interesting one. I take a stance that seems to vary from most. What I mean by that is many experts argue you need reserves in the bank. The part of that argument I agree with is that you need reserves. They DO NOT need to be ‘Unemployed Dollars’. Does that bank profit when you have money in checking or savings? Do you? The fact is, you need reserves but those reserves can come in many different forms even in the form of a Debt Weapon. To Learn about Debt Weapons go to www.DebtWeapon.com and watch the free training. Fact is, if you’re not safe, you should NOT pay down your mortgage. The standard rule is to have between 3-12 months of EMPLOYED RESERVES in case of emergency.
Do you have NON-Mortgage Debts?
So why is your mortgage considered by some to be "good debt"? Is it not the largest amount of money you will ever owe? Is it not true that some of the most qualified experts don’t even consider your primary residence to be an asset? The reason mortgages are CONFUSED with ‘Good Debt’ is because other debt such as credit cards, auto loans, student loans etc can often include a much higher interest rate. So the concept of the cost of money being cheaper is the reason mortgages earn this favorable title. The fact is focusing your efforts on NON-Mortgage debts first is generally a wise decision. To do so consider these 4 factors and design the strategy that is MOST beneficial:
- Target Rates: Take the minimum payment of each debt and divide it by the balance owed. This is the TARGET RATE. This number is different than the interest rate as it symbolizes the cash flow advantage you could expect by paying off the highest target rate first.
- Type of Account: The terms of debt varies. For example, an auto loan is not treated the same way a revolving debt is. If you paid only part of an auto loan, the payment generally stays the same, so the cash flow advantage may not be the same as paying a portion of a credit card which would reduce your payment as well.
- Interest Rates: Some experts argue that the highest interest rates should automatically justify that debt being paid first. I disagree. ‘Interest rates are interesting’. Important? Yes. As important as the banks would like us to believe? No. Without considering the 3 other factors on this list, you are neglecting to consider variables that could have a tremendous impact on your finances.
- Impact to Credit: There are 5 components to your credit scores. The one most of us have been taught about is paying bills on time. Although important, paying your bills on time only affects 35% of your credit score. The other 65% is made up of 4 other elements that many people are ignorant to. To learn about the mysterious FICO® credit scoring formula, visit the free training at www.PersonalCreditScoresRevealedClass.com .
What About Retirement Accounts?:
Obviously ignoring getting an employer's full match, many retirement accounts are underperforming. Even still, some people are still better off contributing to a retirement plan because of the tax benefits and the potentially higher returns on your investments than what you might save on an OWNER OCCUPIED mortgage. Keep in mind a real estate investor is paying much higher interest rates and does NOT get the same tax advantages because of interest costs.
This always interesting debate begs us to consider one’s desire to take risks. The fact is, investing in debt results in guaranteed returns. Few investments do, especially 3-5% or MORE.
None of what we’ve discussed (except the employer match) applies if you're going to put your retirement savings into a money-market earning less than 1%. If you're sick of the volatility of risk, paying down your mortgage early may be your best option.
We’ve made the case for years that it’s not good enough to just be debt free. My friend Michael say’s “Keep your arrows going in the right directions. Income and assets should always be moving up, and liabilities should always be moving down.” Now as obvious as this may be to interpret, it is more difficult for many to implement. The fact is, it IS possible to achieve both simultaneously. When you successfully do so you can rapidly increase cash flow, which is the essential ingredient financial safety.
How Near to Retirement?:
When you’re in or near retirement the calculations look a little different. If you're an anomaly and you’ve had your mortgage for a while, you're further along your amortization schedule and paying much less interest. Therefore you're not really benefiting from the tax deduction. You also won't benefit as much by investing the money instead, since your investments are likely to be more conservative. Also, if you are currently retired, you're not eligible to make contributions to a tax-advantaged retirement plan anymore. In fact, you might need to make withdrawals from retirement plan accounts just to make the mortgage payment. If you have less than five years remaining on your mortgage, it may make sense to pay off the mortgage early.
To see a compelling argument for living 100% debt free including your mortgages, watch www.DebtFreeWebinar.com .