December 27, 2007  

Is paying off a mortgage earlier the best strategy for a homeowner? The main question many homeowners should ask themselves is: “Should I build wealth or just focus on reducing my debts.” 

Many families are making extra payments towards their mortgage every month to attempt to reduce the interest on their home mortgage. It is true that a family with a $350,000 mortgage at 6% interest would end up paying $405,433.65 in interest over the life of a 30-year mortgage. When you know that by adding an extra $200 per month you could lower your interest payments by $95,091.83 and pay it off 7 years earlier it is very tempting to add extra money towards principal. But is it the best strategy for a consumer?

While such a strategy can reduce interest payments over the life of the loan, and speed up paying off a home mortgage, it may not be the best use of consumers’ money. My great concern is that you may accomplish paying off your mortgage early, but if you’re not doing any other saving, you may enter retirement broke. I think it should be more important for homeowners to focus on creating wealth than to eliminating a mortgage. Speeding up the payment of a mortgage may not be as beneficial as dealing with other debt.

Debts such as credit cards, car loans or student loans often carry much higher interest rates than mortgages, and interest payments on such consumer loans are not tax deductible like mortgage interest is. A homeowner should never consider applying more money to a home mortgage until high-interest credit cards are paid off and a 6 to 12-month emergency cash reserve account has been built.Tying up all your money in an illiquid asset such as a home, which has no rate of return, is not a great strategy if a homeowner has not yet built an adequate emergency savings.

How will you pay your mortgage and other bills if you have no cash reserve and you lose your employment or get seriously sick and can’t work for a few months? Do you think your lender will make you a favor and wait till you get better? I don’t think so. Your lender will want your money on the due date of each month, and that’s the contract you signed.

A smarter use of your money would be to contribute to a 401(k) retirement account to maximize the employer match, fund an IRA or Roth IRA. A homeowner with a 6.5 percent mortgage interest rate in a 28 percent tax bracket, after-tax cost of borrowing money is about 4.68 percent. That’s cheap money!

A great question for every homeowner should be: “Can I get better rate of return than 4.5 percent true borrowing cost, on any another investment?”  The answer is usually yes. I highly suggest that homeowners considering an extra mortgage payment review the following list:

Do you have any debt that with a higher interest rate than the rate on your mortgage? If yes, you should be putting your extra money against that debt first.

If you have no debt, are there investments that are likely to give you a better after-tax return than your mortgage? 

Do you have 6 to 12-month cash reserve in a savings account? If you don’t have enough money to cover at least six months of living expenses, you should create that emergency fund ASAP.

Prepaying a home mortgage can be a wise decision for someone with a low mortgage balance, where you pay very little interest as you have been paying your mortgage for over 20 years and you are approaching retirement. Everybody else should consider building wealth using their home mortgage. There are home equity strategies that will help homeowners enhance their wealth.

To Your Success,

Andre Plessis

The Mortgage Guru

Website: http://apply-free.com