Mortgage Dilemma: Should I Pay Down Principal?
- How many have found themselves in this situation?
You have a mortgage, you’re looking at your savings account, you see a sizeable sum. From working with a fiduciary financial advisor you already have an emergency fund comprised of high-yield savings accounts, bonds and maybe fixed income funds so you are prepared for any sudden life events. Do you pay down your mortgage? Do you invest? Can you lower your monthly payments? So many choices! These are important questions and I would like to provide some helpful answers, breaking them down into two (2) categories – Math & Emotion.
Math: Math almost always tells us NOT to pay down our mortgage. Here’s why.
- Is your mortgage balance $1,000,000 or below? All mortgage interest on a balance of $1,000,000 or below can be taken as an itemized deduction on your tax return. Great – why do I care? Because this deduction lowers the true cost of your mortgage!
- Example: Say you’re in the 28% federal tax bracket with a mortgage at 3.50%, your true cost is only 2.52% per year.1 This is because you are getting a $0.28 cent deduction on your tax return for every dollar of mortgage interest you pay.
- Can you exceed your mortgage cost in investment returns? With mortgage rates still low, many people are able to earn more than the cost of their mortgage by investing those dollars over the long-term in the market.
- Example: Take the information above and assume your true mortgage cost is 2.52%. The S&P 500 has provided a 7.2% annualized return over the last 30 years.2 If you paid in full for your home back in 1987 instead of getting a 30-year mortgage, then you just missed out on an extra 4.5% return compounded each year since then.
Emotion: Math is not the only thing that matters.
- How does having a mortgage make you feel? If your mortgage is the mental road block that has always kept you from feeling financially secure, maybe you do pay down part of your balance regardless of what the math says. Financial security shouldn’t just be something that you’re told but something that you feel. Confident that you and your financial advisor are on the same page, being able to get a comfortable night’s sleep counting sheep instead of running budgets.
- Recasting – and I don’t mean fishing. If you have cash and you have decided that you will feel best putting it towards your mortgage, see if your lender offers recasting.
- Recasting allows you to pay down your mortgage with a lump sum and have the lender re-amortize keeping the same interest rate and term. This then lowers your monthly payment for the remainder of your mortgage. Cost of a recast can be around $250 and the minimum amount required varies ranging from a sum of $5,000 up to 10% of the remaining loan balance.
These are some of the key factors in the daunting mortgage pay down conversation, but of course there is always more insight to be given from a Fee-Only, Fiduciary Advisor. Who won’t be getting paid more whether you decide to invest or to pay down, because they are there to help you along your journey and achieve the ever coveted Financial Independence.
1(28% of 3.5% = 0.98%) 3.5% – 0.98% =2.52%