Recently, many people have been asking "if I can afford to do it, should I pay off my mortgage?" Generally, I have heard people say that making additional principal payments on a mortgage is not the "smart" thing to do. The ratione is usually that stocks historically return about 10% over time, which would generally exceed the interest rate on your mortgage.
From an investment standpoint this is a very easy question to answer. Because of the low interest environment we have been in over the last several years, most people have mortgages in the 6% range. So bottom line – can you make more than 6% on your investments?
Generally, the answer to this question is that it is a bad idea from an investment standpoint. You'll make a lot more than 6% investing in real estate. Even the stock market will earn you 10% over the long term. But it is actually more complex than that. The reality is – will you be able to stomach the volatility you could encounter in other markets?
Let's face it, investment decisions are not always about the "best" financial decision. Your personality and personal preferences always play a part. If making a financial decision allows you to sleep better at night, then that may be the best decision for you. You just need to realize that from an investment point it may not be the best decision.
When I refinanced my mortgage a year and a half ago, I took out a 30 year fixed at 5.25%. At the time a 5 year CD was paying 4.75% to 5.00%. So for me the decision was a no-brainer. I needed to pull out as much as possible, because even if I did not invest it in real estate (not sure this is even possible for me!), I could put it in a CD and almost break-even. In fact, I believe that I am actually assured that CD rates will average a lot higher than 5.25% over the next 30 years. So for me the answer to "should I pay off my mortgage" is an easy one – no.
But for many people this approach simply will not work. Why? Because they will take the money and spend it rather than invest it. The temptation is just too great.
In addition, when you make additional principal payments on your mortgage you lose some flexibility. Assuming you do not refinance or pull the money out with a line of credit, you do not get those extra principal payments back for awhile.
People often say for example "if I pay an extra $ 200 a month it will save me $ 100,000 over the life of the mortgage." While this may be true, people fail to realize that $ 100,000 savings over a 30 year period does not have the same present value as $ 100,000 today. This is similar to someone who bought a house for $ 45,000 in 1968 that is now worth $ 300,000 and they can not believe how much it has gone up. The appearance is that the home appreciated substantially. But in this example, it is a compound rate of only 5%. This applies to the question "should I pay off my mortgage." The perception is that the savings is substantially greater than it is.
So, in theory, you should take any money that you would use to pay off your mortgage and invest it in more real estate, stocks, or a mutual fund. Sounds pretty easy. But the reality is that most people are not very disciplined. So for many people, making an extra couple hundred hundred dollars a month payment may be a good idea. I'd rather see you pay off your mortgage rather than spend the money on frivolous consumer items. You just need to acknowledge that it is not the best investment decision. But sometimes that's OK. We all have our limitations.
So if you find yourself asking the question "should I pay off my mortgage", you now have a basis for making an intelligent decision. If you are too tempted to spend that additional money or you want to sleep better at night, then by all means pay off the mortgage. Do not fear – it will not be the end of the world.