By Jessica Lanning, JD, CFP®

Just when I think I’ve finally gotten through to my family, friends, clients and loved ones, it happens again – someone tells me about their recent (poorly considered) extra payment on their mortgage, relaying the story with pride.

I don’t even bother asking why.  

I reflexively shot back with “Stop that!”

Making Extra Payments Is a Suggestion, Not a Commandment

I’m not sure where the idea got started or who started it, but paying off one’s mortgage faster by

…making an extra payment 

…or adding $100 to each payment 

…or sending your tax refund or couch coins to your mortgage company 

is not usually a great idea.

And, yes, I’ve seen the calculations too.  If you pay down the mortgage, you will pay less in interest and ultimately pay less on the house overall.   

The math isn’t wrong.  

Your thinking and prioritization might be.

The intentions of this mortgage pay-down road are paved with good intentions:

I want my mortgage paid off by the time I stop working.

I want to own my home outright so I can never lose it.

I want this monthly payment off my list of bills.

I believe real estate is a good investment.

None of this thinking is wrong, either, but it’s misguided.

Most people are starting with the wrong question and the wrong analysis when it comes to paying off their mortgage quickly.

People commonly overlook the following:

They have no intention of living in the home after retiring or until they die.

People are typically refinancing for some reason about every 7 years.

House values can go down, so you can lose the money you put into the home equity.

You cannot put your ATM card into the side of your house and get money out.  You have to sell or refinance.  

And here’s the big one….

Home Equity Has a Return of Zero.

Seriously, zero.

If you put your money into your home by paying down your mortgage, your rate of return is zero on that money.  

Think about it:  Your house will (arguably) grow in value whether you have a loan on it or not.  The size of the loan or the amount of equity in it has nothing – nothing! – to do with the home’s value.

All you are buying is home equity, and it has no return.  

Yes, you will save money on interest, but saving money on interest is NOT the same as making money on your money.

Your Primary Residence Is Not a Great Investment

Somehow the idea that real estate is a good investment got collapsed with a primary residence being a good investment.  Not really.

Primary residences are not great investments.  They are places to nest.  Yes, you can make money on them, sell them, pay any capital gains taxes, and live off that cash.  But you will likely need to spend money on a place to live after you sell.  

In contrast, an investment property has a renter paying the mortgage and other expenses and even if the home never appreciates, the rent will create cash flow to its owner over time.   Unless you take on a border, your primary residence will never do this. 

I’m a huge fan of investment real estate in the context of a financial plan.   A residence is not that.

Saving on Loan Interest Is Not Always the Smartest Move

Let’s say you have an extra $500 burning a hole in your pocket.  

Start with this question instead:  What is the highest and best use of that money

Consider the following:

If you do not have 6-12 months in cash in a reserve account, put it there.

If you are not maximizing your retirement savings options (employer plans, IRAs, Roth IRAs), put it there.

If you have dependents and no life or disability insurance policy, put it there.

If you do not have a long-term care insurance policy, create an account to pay for those expenses and put it there.

If you need to replace a car or other large expense at some point and are not saving for it now, put it there.

If your home needs a repair, put it there.

If you want to create tax-free income in retirement (think Roth conversions), put it there.

If you’ve made money in an investment in the last 10 years and still like it , put it there.

If you want to help a grandchild with college funding, put it there.

If you think owning real estate is a good investment, buy an investment property and put it there.  

Perhaps now you understand why most wealthy people do not pay off their mortgages.  Why?  See the list above.

Can’t I Just Refinance?

Yes, I know you’re thinking that you’ll pay down the mortgage and then you’ll take money out through a home equity line of credit or a refinance if you need it.  

Many big, huge problems with this, such as:  

(1) you can’t refinance if you don’t have a job, which is why you might need the money in the first place; 

(2) the value of your home may have dropped, jeopardizing a refinance;

(3) that mortgage interest is likely no longer deductible.

Chances are you chose to pay down your mortgage because it was a financially conservative thing to do.  If you consider the above, it was actually a very financially risky thing to do.

When Paying Down the Mortgage Makes Sense

There’s really only two people who should pay down their mortgages:

People who overspend on depreciating assets.  If that same $500 is going to end up at a department store on clothes or other things that don’t make money, that $500 ought to go to the mortgage.  It won’t make any money but at least it stands a chance of being available.

People who don’t want to make more money on their money and it truly is burning a hole in their pockets.  

Otherwise, there are better places to save your money.

If you want to talk about paying down your home quickly, please reach out.  

 

Jessica LanningAbout the Author:

Jessica Lanning JD, CFP® brings focus and perspective to your individual financial needs to identify your opportunities for investment and wealth. Regardless of what you’ve done before or what “mistakes” you think you’ve made, Jessica can help get you back on track quickly and safely. As a former practicing lawyer, she brings a comprehensive approach to legal, tax, and financial challenges so that her clients can enjoy peace of mind. A huge proponent of conscious decision-making, Jessica makes sure her clients are educated and informed so that they make sound decisions with clarity and confidence.  Lanning Financial Inc. is a registered investment adviser. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

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