What are the advantages of paying off a mortgage quickly?

Question

What are the advantages of paying off the mortgage quickly??

Sure, not paying interest and truly owning your house is great, but then the money is tied in a fixed asset, and if you want to get at that money, the banks charge higher interest rates on equity loans vs mortgage loans.

Not to mention that one could invest the cash at a much higher rate than mortgage loan, giving net profit after the mortgage interest is paid.

I don't think the numbers matter a lot, because as someone said, they vary by location and individual case. The banks are in the business to make money, so you'll never see them loan money for less than they borrow. I am in Canada, so roughly a 5 year mortgage rate is 3.00%, and equity loan is 3.65%. Suppose my mortgage is $200k and I'm paying $700/month, $350 of which is interest. I also have $100k in cash. Now, its not hard to build a very conservative portfolio that will earn at least 5%, which means I'll keep at least $800/year after mortgage interest is paid.

I have heard "paying off your mortgage is good" so many times that I am wondering if there is anything I'm missing?

Answer 1

The main reason for paying your mortgage off quickly is to reduce risk should a crisis happen. If you don't have a house payment, you have much higher cash flow every month, and your day-to-day living expenses are much lower, so if an illness or job loss happens, you'll be in a much better position to handle it. You should have a good emergency fund in place before throwing extra money at the mortgage so that you can cover the bigger surprises that come along.

There is the argument that paying off your mortgage ties up cash that could be used for other things, but you need to be honest with yourself: would you really invest that money at a high enough rate of return to make up your mortgage interest rate after taxes? Or would you spend it on other things? If you do invest it, how certain are you of that rate of return? Paying off the mortgage saves you your mortgage interest rate guaranteed.

Finally, there is the more intangible aspect of what it feels like to be completely debt free with no payments whatsoever. That feeling can be a game-changer for people, and it can free you up to do things that you could never do when you're saddled with a mortgage payment every month.

Answer 2

Considering that it's common for the monthly mortgage payment to be 25% of one's income, it's an obvious advantage for that monthly burden to be eliminated.

The issue, as I see it, is that this is the last thing one should do in the list of priorities:

1. Deposit to one's matched retirement account
2. Have a small emergency fund (fix furnace / car repair level)
3. Pay off any high interest debt
4. A serious long term fund, 6-9 months, in case one is unemployed.
5. Any other debt with rates higher than the mortgage.
6. If you are risk tolerant, pretax savings, else skip to #7
7. Ok to prepay mortgage

The idea of 'no mortgage' is great. But. You might pay early and have just a few years of payments left on the mortgage and if you are unemployed, those payments are still due. It's why I'd suggest loading up retirement accounts and other savings before paying the mortgage sooner.

Your point, that rates are low, and your expected return is higher, is well presented. I feel no compulsion to prepay my 3.5% mortgage.

As the OP is in Canada, land of no mortgage interest deduction, I ignore that, till now. The deduction simply reduces the effective rate, based on the country tax code permitting it. It's not the 'reason' to have a loan. But it's ignorant to ignore the math.

Answer 3

I used to think that paying off ahead of time made sense, but I no longer do, at least in most cases.

The upside is that you can get a return on your money equal to the mortgage interest rate (it's less than that in the US, where mortgage interest is deductible, so it's roughly the mortgage interest rate * 1 - your marginal income tax rate).

There are a few downsides. The biggest is that cash is the most liquid asset you can have; you can get at it with no restrictions. If you put that cash into your house, you are converting that into an asset with a lot of restrictions; you can't get at it without fees, nor can you get at it if you don't have a job, which is when you would need it most.

So, you are putting your money in a hard-to-get-at place for a small interest rate. I don't think it is worthwhile.

(edit) One complication is PMI. If you are currently paying PMI, it may make sense to put money towards the mortgage until you get to 20% and can get rid of the PMI.

Answer 4

It depends on where you are in life, and where you want to be at some point in the future, and the taxes, expenses and income at those points in your life.

You don't get a mortgage to save on taxes, or keep a mortgage to save on taxes. But if somebody said they want to have the house paid off before they retire, that sounds to me like a great plan.

They do need to balance it with saving for retirement, emergency fund, and college costs for themselves or their children.

Without having the whole picture it is impossible to say doing X is always a good idea.

Answer 5

The financial reasons, beyond simply owning your home outright, are:

• You're no longer paying interest. Yes, the interest is tax-deductible in the U.S. (though not in Canada), but the tax savings is a percentage of a percentage; if you paid, say, $8000 in interest last year, at the 25% marginal rate you effectively save $2000 off your taxes. But, if you paid off your home and had that $8000 in your pocket, you'd pay the $2000 in taxes but you'd have $6000 left over. Which is the better deal? In Canada, the decision gets even easier; you pay taxes on the interest money either way, so you're either spending the $8000 in interest, lost forever as cost of capital, or on other things.

• Whatever you're earning is going into your own pocket, not the bank's. Similar to the interest, but also including principal, a home you own outright is a mortgage payment you don't have to make. You can now use that money, principal and interest, for other things.

Whether these advantages outweigh those of anything else you could do with a few hundred grand depends primarily on the rate of return. If you got in at the bottom of the mortgage crisis (which is pretty much right now) and got a rate in the 3-4% range, with no MIP or other payment on top, then almost anything you can do with the amount you'd need to pay off a mortgage principal would get you a better rate of return. However, you'll need some market savvy to avoid risks.

In most cases when someone has pretty much any debt and a big wad of cash they're considering how to spend, I usually recommend paying off the debt, because that is, in effect, a risk-free way to increase the net rate of return on your total wealth and income. Balancing debt with investments always carries with it the risk that the investment will fail, leaving you stuck with the debt. Paying the debt on the other hand will guarantee that you don't have to pay interest on that outstanding amount anymore, so it's no longer offsetting whatever gains you are making in the market on your savings or future investments.

Answer 6

From my experience and friends' experiences, I can say that there are advantages and disadvantages for paying off your mortgage quickly. Basically, it depends on these factors: the type of the mortgage, its interest rate, your financial stability, your skills in making investments and other outside factors, such as inflation, liquidity, oppurtunity cost, etc. Paying it off means you save on interest ratings, you decrease investment risks and your investment rates are taxable. Disadvantages are that you cannot use this money for investing, you cannot use this money for tax deductions and that in a state of inflation, not paying it off in advance could save you a lot of money. However, I always recommend to read some more on websites that deal with mortgages, and speak with the mortgage expert in your bank.Just acquire enough information to make a good assessment. An interesting article on this topic - The Advantages and Disadvantages of Paying Off Your Mortgage