Don't Pay Off Your Mortgage Early

Paying off your mortgage early is one of the best things you could ever do for yourself financially, right? Wrong. It's one of the best ways to shoot yourself in the foot. When you pay off your mortgage early, you deprive yourself of some wonderful benefits. Furthermore, in a twist of the utmost irony, you can actually increase the risk of losing your home!

The allure of paying off your mortage early is saving tens, possibly hundreds of thousands of dollars in interest over the life of the loan. But people often forget to account for the hundreds of thousands, perhaps millions of dollars they're missing out on by having that money sitting there idle in home equity instead of compounding over the years in stocks.

Put it this way. 30-year fixed mortgage rates have averaged roughly 8% over the long term. Factor in the tax deduction and you're looking at an effective rate of about 6%. On the other hand, large-cap U.S. stocks (the safest kind of stocks) have averaged about 10.4% over the long term. Let's factor in the taxes on distributions from a mutual fund and call it a 9% return. So when you put extra money into stocks instead of making extra payments on your mortgage, you're paying 6% in interest to make 9% in capital gains. 9% is more than 6%, and it really isn't any more complicated than that.

So why do so many people think it's a good idea to pay off their mortgage early? To a large extent, it's a remnant of the Great Depression, when banks could call a loan due at any time. So if you ever owed more on your mortgage than you could pay on the spot, you were at risk of losing your home. Fortunately, this can't happen today. In fact, you may be more likely to lose your home if you put too much money towards your mortgage.

How can this happen? I once heard of a woman whose main goal was to make sure her house was safe from the bank. With every mortgage payment, she put as much extra as she could afford towards her principal balance. Until one day she got laid off from her job. Of course, she still had to make her mortgage payments, but where would the money come from? She didn't have any savings because she had put everything into home equity. She couldn't get a home equity loan because she didn't have a job. So she ended up losing her house because of (not in spite of) her efforts to save it.

By not paying off your mortgage early, you enjoy the benefits of leverage and a federal tax deduction. The amount you pay in interest can easily be made up by wisely investing the extra money you'll have compared to someone who makes additional payments. And by having money outside of home equity, you'll be better prepared to make the payments that never end. That's right, never. Even if you pay off your mortgage completely, you still have to pay property taxes. And without a mortgage lender to escrow them for you, you'd better be sure you never miss a payment.

Of course, everyone feels an emotional connection to their home, and somehow we just feel safer knowing that we're getting closer to owning it free and clear. But this feeling of safety just isn't justified by the numbers. Take a look at how much you owe on your mortgage (let's say it's $150,000), and how much you pay for principal and interest each month (let's say it's $700). Then ask yourself, does it really seem like a good deal to put down a small fortune of $150,000 just to save a measly $700 a month in tax-deductible payments?