Archive for Monday, February 24, 2003

Experts disagree on wisdom of paying off mortgage early

February 24, 2003


My grandmother couldn't wait to pay off her mortgage. Big Mama's goal was to retire with no house payment.

Big Mama reached her goal. She retired at 65 and died at 82, giving her 17 years without having to worry about a mortgage.

However, many financial planners these days tell aging homeowners not to worry about paying off their mortgage.

In fact, in his best-selling book, "Ordinary People, Extraordinary Wealth,'' Ric Edelman argues that paying off your mortgage early or making extra mortgage payments is a big mistake.

"Here's why: You know that by reducing the mortgage payment, or even paying off the mortgage completely, you save lots of money in interest charges,'' Edelman writes. "While that is correct, you are ignoring another, equally critical fact: Every dollar you give the bank is a dollar you did not invest.''

Edelman, like many experts, also points to the tremendous tax break homeowners get.

Personally, I've been vacillating on this issue. I want the peace of mind of knowing the roof over my retired head is paid for. Yet I'm not sure it's wise to make extra principal payments or pay off my mortgage early, because if I need my cash in the future, it will be tied up in my home. The only way to tap into that cash would be to either sell my home or get a home equity loan -- which will cost me more money.

Couple offer example

Based on my mail, there are a lot readers who, like me, can't decide what to do. In fact, I recently received this question from a reader:

"We have 19 years remaining on a 30-year mortgage. The remaining mortgage amount is $158,000 on which we are currently paying an interest rate of 7.5 percent. This costs us about $1,300 per month.

"We have the cash to pay off the mortgage (which would still leave us with $150,000 in cash and $600,000 in investments). We have no other debt. Why should we pay 7.5 percent on the mortgage when I can't make that on our money under any current investment scheme? If we should need a large sum of money in the future, then we could take out a home equity loan. Still, something feels strange about parting with all that cash, even though it would save us thousands over the long haul. What are we missing?''

Paying off early

To answer this reader, I consulted two financial planners. First I asked Dee Lee, a certified financial planner and author of "The Complete Idiot's Guide to Retiring Early.''

"I am a big fan of paying off the mortgage on homes,'' Lee said.

Lee said if the couple has $358,000 in cash sitting in a money market account paying a puny 2 percent interest -- if they're lucky -- it would be better for them to pay off the mortgage. It's a better return on their money, she said, given the current stock market condition. And she advised the couple not to worry about what they would be losing by way of a tax deduction.

"Better to have never paid $100,000 in interest than to have paid it and gotten a tax deduction for it,'' Lee said.

Investing extra funds

James R. Cotto, a financial planner based in Mount Kisco, N.Y., had different advice for the cash-flush couple.

He points out that the couple's net worth, including the value of their home, is about $1.1 million. If they paid off their mortgage, about 34 percent of their net worth would be tied up in their home.

"With interest rates at near 40-year lows, it makes sense to refinance,'' Cotto recommends.

If the couple refinanced into a 15-year mortgage at 5.5 percent, their monthly payment wouldn't go down much -- only about $10 a month -- but they would save about $65,000 in interest.

Cotto said the couple should consider keeping their cash to invest.

And, although investment returns are dismal right now, stocks have averaged a return of about 11 percent since 1926.

In addition, he said most experts feel that real estate should make up no more than approximately 25 percent of an individual's investment portfolio.

So here we are, right back where we started. Still not sure what to do? Here's my two cents' worth.

Think about your current and future financial needs. For example, my husband and I have decided to invest any extra money we have rather than make extra mortgage payments. We have three small children to put through college so we don't want to tie our money up in our home.

However, if you are like Big Mama and you would feel more secure paying off your home, then do so if you have the means.

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