Consider Paying Down Your Mortgage Now to Save Later
Consider Paying Down Your Mortgage Now to Save Later
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Consider Paying Down Your Mortgage
How to earn 3 to 6 percent annually with no risk
Istock Could a down payment on your mortgage be the best bet when it comes to tax advantages? Tens of millions of Americans can earn a risk-free 3 to 6 percent annual return by paying down their . Can it get even better? Yes, it's quite often tax-advantaged as well. If you have enough money in the bank or in investments to do it, consider the logic behind my claim and why you rarely hear this advice. First, it's important to understand that a mortgage is merely the opposite of a bond. When buying a bond or bond fund, you are lending money to corporations or governments that, in turn, pay you interest and your principal back, unless there is a default. Minimizing the risk of default is why bonds should be boring. When taking out a mortgage, you are paying a bank or other party principal and interest, which must be paid back irrespective of whether your house appreciates.Simple illustration
Let's take an example of a consumer with a $100,000 mortgage at 4 percent annual interest and who is in the 30 percent marginal tax bracket (combined federal and state). He or she could invest in high-quality bonds such as the iShares Core U.S. Aggregate Bond ETF, or a five-year CD, both yielding about 2.25 percent. By doing so, they would earn $2,250 before taxes and $1,575 after taxes.AARP Discounts
as an AARP member. If they instead paid off their mortgage, they would save roughly $4,000 in interest payments, possibly lose out on $1,200 of interest deductions, and have a net savings of $2,800. So I make the case that the consumer comes out at least $1,225 ahead by paying off the mortgage. The consumer pays more in taxes but, much more important, makes more money after taxes. In many cases, I've found the consumer isn't even getting the full value of the mortgage deduction. If their income is fairly low, they'd do better by taking the standard deduction instead of itemizing their deductions. If they have high income, tax law hits them in other ways, such as phasing down the mortgage deduction. So paying down the mortgage is tax-neutral at best and often tax-advantaged.Faulty arguments against paying down the mortgage
Here are three of the most common arguments I regularly hear to counter my advice. A more balanced portfolio of, say, 60 percent stocks and 40 percent bonds can earn more than what you'd gain by paying down your mortgage. Though this may be true, it is more a case of comparing apples to oranges. This argument is analogous to taking out a margin loan on your brokerage account to buy more . You might earn more if your stocks go up, but I would not recommend it, even though margin loans are often at lower rates than mortgages. Also, I've heard this argument for decades and, so far this century, bonds have outperformed stocks. Borrowing to buy more stocks has backfired. You don't want to put more money into the house. While I agree with this statement, it's irrelevant. I'm not suggesting a house remodel here. Again, paying down the mortgage has no impact on the price you ultimately sell your house for. If you don't fully pay off your mortgage, your monthly payment typically will not change. This statement is also true, but it's not the full picture. Because a much greater proportion of the monthly payment is going toward principal as you pay down your mortgage, the mortgage is paid off much sooner and you still save the interest payments.More From Allan Roth
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