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Should you pay down your morgage or not?

Posted: July 31, 2012 2:00 a.m.
Updated: July 31, 2012 2:00 a.m.

Security and peace of mind are everyone’s concern. More than ever before, having “a roof over your head” seems so important.

When it comes to a home, one question often comes up: “Should I pay down my mortgage?” This question comes up a lot for people who are a bit older and have retired or for those who have inherited some money or possibly liquidated another asset. It can be confusing, but there are some things to consider.

Many of the same considerations will apply whether considering making a slight overpayment on a regular basis, an extra one every so often or a large payment all at once. In fact, people often pay down their mortgages without really knowing why.

Yes, it seems obvious; they’re paying it down to eliminate it sooner, ultimately saving money in interest. But in my world the why means: Why have you chosen this instead of other options that might be more beneficial?

I’ll never make a blanket statement and say not to pay down your mortgage, but I will say that for many either doing it or considering it, there are better options.

One problem I see often is people making overpayments when they will never actually pay their loans off. Based on their anticipated time in the home or their expected life span, that opportunity may never come. In this example, you will never truly benefit from ending the loan early. All you will have done is move assets from one place to another. Let me explain.

Assume your home is worth $200,000. You have $100,000 in the bank and a $100,000 mortgage balance. You effectively have $200,000 in net assets; $100,000 from cash and $100,000 from equity.

If you were to take $50,000 from the bank and apply it to the mortgage, how much in net assets would you have? It’s the same, $200,000. You’ve only moved the asset. Here’s the problem: the money that was in the bank and now in the house has lost the opportunity to grow. Allow me to explain further.

If your home is worth $200,000 with a $100,000 mortgage and the price increases by 10 percent you have gained $20,000 in equity.

If you had put the $50,000 into the house and it grew by the same 10 percent, how much equity would you have gained? It’s the same $20,000. You don’t gain any more because you’ve added money to the house. The money that went into the house to lower the mortgage balance will never grow again. It could even be lost if equity was reduced dramatically, but it will never gain another dime. Of course it will allow you to pay off your home earlier if you get to that point, assuming you’ll actually achieve that. Up to that point the money just sits.

If the money had been left in the bank or with another opportunity, it could continue to grow and potentially be of more benefit down the road. Even if it earned only 1 percent, it would still be better than nothing.

In the first scenario, when you eventually sell your home, you would get back the $50,000 you had originally used to reduce the mortgage and you would put it into your savings.

If you kept the money invested outside of the home, it would still be in your savings, except it could be greater than the $50,000 because it would have been growing the entire time.

I hope this made sense. There are various other things to consider. For instance, paying down the mortgage gives you the option to refinance at a lower rate. There’s also the option of creating an income from your assets that’ll help with your mortgage payment, rather than using it to reduce the payment in a lump sum.

The point is there are options. Very often, simply “putting money into your home” is not the best one. I do say, however, sometimes peace of mind is more important than what the calculator tells us is right.

Everyone’s circumstances are different, and a good advisor will help you explore the various paths and make sense of which options are best for you.

Jerry Citarella is the owner of Infinity Wealth Management 23734 Valencia Blvd., Suite 301, Valencia, (661) 255-9555, ext. 11.  He is also the author of The Truth Helps Series of financial planning books. Mr. Citarella’s column reflects his own views and not necessarily those of The Signal. Submit questions to:  Securities and investment advisory services offered through NEXT Financial Group Inc. Member FINRA/SIPC.  Infinity Wealth Management is not an affiliate of NEXT Financial Group Inc.


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