In my previous article, How to Save Thousands of Dollars in Interest on Your Mortgage, I discussed the nuts-and-bolts of the various techniques. But now, let’s discuss the pros and cons.
Most homeowners want to own their homes free and clear. For some, that means using a raise, inheritance or savings to pay off their mortgage early. But this seemingly responsible move may not always be in your best financial interest.
According to financial experts, paying off your mortgage early actually comes with a cost to your bottom line. The reason lies in simple math: the amount you’ll save in interest likely won’t exceed what you would earn in other long-term investments, such as stocks.
For investments to make more sense than paying off a mortgage early, the annualized rate of return over a certain number of years would only need to make more than the mortgage interest. And since most people are sitting on relatively low mortgage rates, between 3.5 to 5.5 percent, beating that rate isn’t tough.
The average annualized return for the S&P 500 index over the past 90 years is roughly 10 percent. Using the cash to leverage more real estate, such as multifamily properties and single-family homes, is another long-term investment that will likely offer higher long-term yields compared with paying off your mortgage.
However, it’s important to work with a financial advisor before you invest so you can fully understand the risks and benefits involved.
Financial experts agree that it’s important to have a portion of your net worth in liquid assets. These are assets that can be converted into cash quickly such as stocks, marketable securities, mutual funds, U.S. treasuries and bonds. A house is considered a non-liquid asset because it can take months, or longer, for a homeowner to sell the property.
Liquidity is important in times of economic downturns and personal emergencies. Its primary function is to be an easy way to access cash when you need it. If your cash is tied up in a house or retirement accounts (which can be expensive to draw from), you could end up having to borrow money in a pinch.
If paying off your house is more valuable to you than earning a few dollars more in stocks, be sure you have a six-month emergency fund saved before you commit a big chunk of cash to your mortgage payment.
Families should strive to have a minimum of three months after-tax wages in the bank and low-income earners should aim for at least $1,000 saved before putting extra toward a mortgage payment.
Financial planning is a process that’s unique to every individual. Spending habits, timelines, how much risk you’re willing to assume — and how much you’re okay losing, as well as your financial and personal goals are all elements that go into an effective strategy.
Paying off your mortgage early will decrease your total mortgage interest, which could save you thousands, as well as help you build equity faster.
According to ATTOM data, 34 percent of homeowners have 100 percent equity in their homes. For many people owning your home offers benefits that can’t be tallied on a computer.
For folks nearing retirement, eliminating that monthly mortgage payment can be a mental relief when they’re facing a fixed income.
Homeowners can also borrow against the equity in their home by way of a home equity line of credit, or HELOC, in case of emergencies or to make improvements to their home. HELOC interest rates are still historically low and if you use the funds to add on or make repairs to your home, then the money is tax deductible.
The important thing is for people to identify their financial goals and to allocate their money appropriately. Although financial planning seems like an exercise in logic, it’s often ruled by emotion. People want to feel good about where there money is and that doesn’t always line up with what a spreadsheet might recommend.
For some people, owing money causes stress, so getting rid of debt is a better use of funds than keeping the debt in order to earn extra in investments.
Original Article by Natalie Campisi
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