Four Reasons Not to Put Extra Money into Your Mortgage
At a time when many Americans are struggling to meet their mortgage payments, you should count yourself fortunate if you are in a position to consider making extra payments to pay off your loan faster. The idea of getting rid of a mortgage and owning your home free and clear has natural appeal, but as with any financial decision, you should carefully examine the alternatives before you act.
Four Things to Think About
There is no doubt that putting money into the roof over your head is a sound decision, but there are other things to think about before you commit extra money to your mortgage lender. Here are four important considerations:
- Diversification. Investors manage risk by spreading their money into different assets. This comes down to the old expression "don't put all your eggs in one basket." For many home owners, their house is their largest single purchase. If you have extra money at your disposal, you may want to take the opportunity to diversify into savings or other investments, rather than simply accelerating the investment in your home.
- Liquidity. A house is a valuable asset, but in financial terms it is highly illiquid--that is, it is difficult to convert that asset into cash should a need arise. Traditionally, home owners have been able to get some liquidity out of their homes by taking out home equity loans, but with mortgage lenders tightening their standards, you have to ask whether you want to rely on that method. Before locking up your money by putting it into your mortgage, think through what needs for the money might arise in the years ahead, and make sure you have enough of a cash cushion to handle emergencies.
- Better Investment Opportunities. When interest rates rise, you might be able to earn more by investing in interest-bearing bonds than you are paying in mortgage interest. And investment vehicles like stocks, bonds, mutual funds, and others have historically paid much higher returns over time than today's typical mortgage interest rates. If retiring your mortgage early is your goal, you can do it more effectively, earn a higher rate of return, and retain your liquidity by investing your money elsewhere until you are ready to completely pay off your home loan.
- Tax Differentials. Everyone's tax situation is different, but for many people, they are able to deduct the interest portion of their mortgage payments. This makes the mortgage cheaper than it may seem. Especially when long-term capital gains rates are lower than most people's income tax rates, it is possible to get a tax break on the borrowed money that is larger than the taxes you'd pay on long-term gains from investing that money.
Paying off a mortgage early is certainly more financially sound than just spending the money, but there may be other investments that make more sense. As with any investment decision, you need to choose carefully and think about the long run.