Pay down the mortgage, or invest?
October 30th, 2005 | by mbhunter |Scott Burns on MSN Money debates mortgage paydown and investment in his article
Dilemma: Should you pay down or build up?
The subtitle of the article states that “[s]ometimes it’s smarter to use extra cash to pay off your mortgage; sometimes you should stoke investments. It all depends on your situation.”
This much is true. No one investment is appropriate for everyone. He also makes the argument for an emergency fund — liquid assets for “times of lean” like job loss, medical hardship, etc. Also a good thing.
One point in the article leave me scratching my head, though:
Many financial planners argue that you should be slow to pay down the debt because:
- its net cost is zero when tax benefits are considered, and
- you can earn a higher return investing the money elsewhere.
He speaks of mortgage debt here. It would be really nice if the first part were true, but it’s not. I’m not sure where this has its basis. The mortgage interest deduction is just that — a deduction — which means that the amount of the interest (subject to some limitations, and only if you itemize) comes off of your adjusted gross income. This results in a tax savings of part of the amount of the interest, but not all of it. So, the debt still costs you. Even if you want to interpret this in light of inflation — that the later interest payments will be “cheaper” because the dollars will be worth less in real terms — the statement still isn’t justified. Because mortgage payments are interest-heavy at the beginning, you’re paying more of the interest with valuable dollars instead of cheap dollars.
Either way, it isn’t free.
If you have a good liquid cushion and your retirement savings are in good shape, then paying down the mortgage is a good thing to do. You get a guaranteed return in terms of mortgage interest saved if you accelerate your mortgage payments. You may be able to do better elsewhere, but the “compounding” of saved interest works the same way as with any other savings vehicle — the earlier you start, the longer it has to compound.
2 Responses to “Pay down the mortgage, or invest?”
By Caitlin on Oct 31, 2005 | Reply
I tend to view the deduction as if the government is paying x% of my mortgage interest where x is my marginal tax rate. For me, it helps keep it in perspective. It certainly reduces the cost of borrowing, but yeah..it ain’t free!
By Adult ADD Money on Nov 2, 2005 | Reply
Financial Planners cater to richer clients. While I agree with you that the net cost is not zero. When you add a low mortgage rate to a high tax bracket it is probably more beneficial to invest rather than pay down the mortgage.