Does a Fast Payoff Make Sense?
September 18, 2000
"My husband and I will be buying a house at the end of this year. We believe we should be able to pay off the home in 7 years by more than doubling our payment. We have been told that we are insane if we do this because we won’t get the full interest deduction benefits, we could invest our extra money elsewhere, etc. Would we be crazy to pay our home off in as little time as possible?"
Define and then assess the alternatives. If you don't use your extra income to repay your mortgage, how would you use it?
You could have more children, travel the world, or fund a retirement home for impoverished finance professors. These are investments that yield no direct financial return, and I can’t advise you on them. They reflect life-style decisions only you can make.
If you plan to invest the money for a financial return, compare the risk and return from prepaying your mortgage against that of other investments.
The return on prepaying the mortgage is the interest rate on the mortgage. This will be about 8%, with zero risk since you are paying yourself.
This is clearly a better alternative than putting the extra income in a bank or money market fund where it would earn only 3-6%.
Suppose, however, your investment alternative is a diversified portfolio of common stock that could yield 12-15%. That might make sense, provided you are prepared for the risk of short-term fluctuations in portfolio value.
A diversified portfolio is a reasonably prudent risk, provided you are in your 30s or 40s and plan to stick with it over the long haul. If you are in your late 60s or beyond, a stock market tumble could crack your nest egg. I suggest that older investors pay off their mortgage early.
"My husband and I will be buying a house at the end of this year. We believe we should be able to pay off the home in 7 years by more than doubling our payment. We have been told that we are insane if we do this because we won’t get the full interest deduction benefits, we could invest our extra money elsewhere, etc. Would we be crazy to pay our home off in as little time as possible?"
Define and then assess the alternatives. If you don't use your extra income to repay your mortgage, how would you use it?
You could have more children, travel the world, or fund a retirement home for impoverished finance professors. These are investments that yield no direct financial return, and I can’t advise you on them. They reflect life-style decisions only you can make.
If you plan to invest the money for a financial return, compare the risk and return from prepaying your mortgage against that of other investments.
The return on prepaying the mortgage is the interest rate on the mortgage. This will be about 8%, with zero risk since you are paying yourself.
This is clearly a better alternative than putting the extra income in a bank or money market fund where it would earn only 3-6%.
Suppose, however, your investment alternative is a diversified portfolio of common stock that could yield 12-15%. That might make sense, provided you are prepared for the risk of short-term fluctuations in portfolio value.
A diversified portfolio is a reasonably prudent risk, provided you are in your 30s or 40s and plan to stick with it over the long haul. If you are in your late 60s or beyond, a stock market tumble could crack your nest egg. I suggest that older investors pay off their mortgage early.