Accelerate Your Mortgage?

As mortgage rates increased this past year and are currently hovering in the seven percent range, I am getting some questions from readers about what to do with their mortgages. Just to clarify, these questions are coming mostly from owners who have been on adjustable-rate mortgages and are all of a sudden finding themselves in a much higher mortgage rate and larger payment than before. 

Paying off a mortgage early or not is a very personal decision. I have clients who just want to own their homes free and clear so that they can have peace of mind that they have no more monthly mortgages or obligations to pay. Some have paid all cash even when the mortgage rate was at three percent so they do not have a large expense.

From a purely financial standpoint, a mortgage loan normally is a loan at the cheapest rate a consumer can get because there is security for the lender. For this reason, it is good to have some liquidity for a rainy day by holding on to the extra money and paying down the loan.

 The decision I like to explain to people is, if you can invest money and get a higher return, perhaps you should consider doing just that instead of paying off the mortgage.

 However, if one wants to start paying off the mortgage early and make an extra payment each year on a 30-year mortgage, you may shorten the loan term by about five years. If you can make a couple more payments every year, that would shorten your loan term by about nine years. By shortening the length of payment, you will save that much more in the long term. 

 But I think the bigger question is whether paying off the mortgage makes sense. Most financial advisors counsel against it because it makes your assets illiquid, and can create a situation where one cannot access the equity when they most need it. Instead, most would advise to keep the cash in safe accounts so that it is available when you have emergencies.

 A mortgage provides tax benefits in that the interest portion may be written off on your income taxes. It is important during the high-income earning years as it is one of the last large deductions you can claim on your taxes. 

 Current mortgage rates, though higher than the last few years, are still at fairly low historical levels, so a loan secured by a home offers one of the least expensive vehicles to the capital markets. And if you can leverage off these funds by investing it in opportunities that yield more than your mortgage rate, wouldn’t that be a better use of funds? Current CD rates are at about five percent, so the difference is not too much if you want to keep the funds very safe.

 Lastly, by having a mortgage, it makes the bank your partner. In the event of a major catastrophe like an earthquake, and your home is destroyed, you may be able to walk away from the loan because the real estate is the sole security for the loan. This is not a position I advocate, but it is a possible scenario.

 The decision to pay off or not pay off your loan is a very personal one because a home represents security. I would recommend that you consult with a qualified CPA or financial planner to discuss your personal situation and proceed accordingly. 

John M. Lee is a broker with Compass specializing in the Richmond and Sunset districts. If you have any real estate questions, call him at 415-465-0505 or email at johnlee@isellsf.com.