Paying off a primary mortgage is important, which is why so many people give it priority over other financial goals. However, this might not always be the best method to grow your wealth. A mortgage can definitely hinder your ability to save, but there are some situations where saving and investing should come first.
Conventional wisdom tells us that paying off our debts should come before growing our personal wealth. In many circumstances, we agree with this theory, but not when it comes to a primary mortgage. Below are several reasons why we take such a hard-line stance on this issue:
Interest Rates Are Too Low to Keep Up with Long-Term Rates of Return
In today's rate environment, many mortgages carry interest rates between 3.5% and 4.5%. This means cheap access to money for 30 years. If we pay down home loans to avoid paying interest, we lose the ability to potentially see gains of 6%, 8%, or even 10% or more over the same 30 year period.
This is called lost opportunity cost and it is frequently ignored by analysts advocating for paying off home loans quickly to lessen interest "costs" over long periods of time. Investing these dollars creates a greater impact on net worth over the life of your mortgage. In short, you could end up losing out on long-term gains by focusing too much on your existing interest rate costs.
You Need Access to Funds to Live Life on Your Own Terms
Life will always find a way to throw you a curveball. By putting all or most excess savings into a primary mortgage, you lose liquidity and access to funds when you really need them. What if a great opportunity comes along to purchase an investment property, but you don't have the funds for the down payment?
In addition to lost opportunities, you may have sudden changes in income (job loss, disability, etc.) that change how you budget your money going forward. Accessing home equity isn't possible without proof of stable income. Maybe you decide to pay for private school expenses for your children 12 years into your 30-year mortgage. Unfortunately, accessing home equity comes with many challenges; having accessible funds makes it easier to live the life you want.
Investing Gives You The Flexibility to Decide When You Pay Your Mortgage Off
By investing and growing money outside of the primary mortgage, you are STILL paying off your home; you just get to decide when. Let's say you are 12 years into a mortgage and you still owe $200,000 on your mortgage balance. Over those same 12 years, you managed to invest monthly and grow your account to a balance of $200,000. In this scenario, you effectively HAVE your home paid off, you just get to determine when you actually write the check.
Do you want to keep the funds liquid because of another investment opportunity on the horizon? Do you want to keep the funds invested because the rate of return has been so much greater than your mortgage interest rate? Or maybe you want to write a check to liberate yourself of the monthly payment REGARDLESS of growth being earned on that investment account. The point is that the choice is YOURS, but the home is paid off either way because the funds are there whenever you decide to use them.
Aggressively Paying Down Your Mortgage Actually Makes Foreclosure MORE Likely in the Future
The bank financing your loan requires you to may the same monthly payment every time. Period. If your monthly payment is $2,000, this is not going to change until your loan balance reaches zero. This means that paying more now could hinder your ability to pay the minimum later.
For instance, let’s say that you start paying down your loan aggressively. 10 years into the loan, you've paid your mortgage balance down to $100,000 from an original $300,000 note. Let's also say that, during that time, you only put a $10,000 emergency fund in place and have no other available funds. In the event that you lose your job or the country experiences a recession, this $10,000 will dry up quickly. If you can't make a mortgage payment on time for two consecutive months, the bank will come calling.
Unfortunately, if your home is worth $400,000 and you only owe $100,000, this will be one of the easiest properties for the bank to foreclose. They can easily force a sale to cover their liability and you may be left without a home. At the end of the day, cash is king. We need cash to help live life on our terms, so aggressively paying down your mortgage can actually do more harm than good.
Are you looking for a financial plan that fits your circumstances and maximizes long-term benefits? Consult the experts at Afton Advisors today for more information!