Don’t Be In a Hurry to Retire Your Mortgage
The final step to debt freedom for most people is to pay off the mortgage. It is tempting to pay it off as soon as possible. The sooner the mortgage is retired, the more interest that is saved. That can amount to a lot of money. No one likes to pay interest. But if you give it some thought, you might not want to be in too big of a hurry to retire your mortgage. There may be a better use for the money that you would use to pay down the principal early.
Remember that prepaying the principal on your mortgage does not affect your mortgage payment. You still have to make that mortgage payment each month, right up until the mortgage is paid off. Money used to prepay principal is spent money. If you get into a financial squeeze, you can’t get it back without taking out a loan or selling the house.
It is difficult to access the equity you have in your house. While equity is an asset, it cannot be utilized without either borrowing against it or selling the house. Furthermore, that equity does not earn interest; it can’t provide an income for you as long as it is tied up in the house. Gains from your investment in the house are in the form of capital gains that are realized when the property is sold. Until then, they remain locked up in the equity you hold in the property.
Financial freedom comes from having assets that you can access relatively easily and that produce income. Money market accounts, certificates of deposit, treasury bonds and notes, municipal bonds, commercial bonds, annuities, and stocks that pay dividends all fall into this class of asset. Focus on accumulating these assets first. Until you have a substantial amount of money in assets of this type, you should go slow in prepaying the principal of your mortgage. Otherwise, you could end up “cash poor” with a high net worth but relatively little cash. Most of your net worth would be tied up in your house.
Putting money into liquid assets, like those described above, rather than a hard asset, like your house, puts time on your side. Those assets will have more time to grow through compounding of interest. You will also have more money with which to deal with any economic challenges that may befall you.
You don’t have to prepay the principal on your mortgage to increase the equity in your house. The value of your house will likely appreciate over time which will increase your equity, even though you are only making regular payments. Of course, whether your house appreciates in value and the rate at which it appreciates depends on when you purchased your house and in what housing market you reside. Some principal is retired with each regular mortgage payment you make which also adds to your equity.
What percentage of your net worth should equity in your house represent? Prior to the Great Recession, the median percentage of net worth for home equity in the United States was about 32%. Post recession, the median percentage remains the same at 32%. The equity in the house Rosa and I own represents approximately 15% of our net worth. You have to decide what percentage is appropriate for you. One thing I know is that if your home equity represents the majority of your net worth, you cannot enjoy financial independence.
Financial experts will argue that it is a more efficient use of your money to pay down your mortgage rather than to put money into savings, because the interest paid on savings is lower than the interest you save on the prepayment of the mortgage. I agree, but it is not in your best interests to put all of your money into paying down the principal of your mortgage when you lack liquid assets.
With mortgage interest rates at historic lows, you sacrifice less now than ever before when you defer prepayment of mortgage principal in favor of building your liquid assets. Yes, interest earned on those assets is low at this time but that will change. The important thing is to put that money aside now and get on the road to financial freedom. You can prepay mortgage principal once you have established a good foundation of liquid assets—first things first.
K.C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages.
[...] and I bought our house in 1985. The house payment, including escrow, was $304 per month. We paid off the mortgage twenty-two years ago. Our basic cost for housing today is $225.00 per month (property taxes and [...]
[...] debt, but especially when we take on long-term debt such as a car loan, a home improvement loan, or a mortgage, we assume that our financial situation will, at the very least, remain the same during the term of [...]
[...] with the neighborhood and want to sell. They paid about $80,000 for the house and have a 30 year fixed-rate mortgage. My nephew said, “Yeah, I didn’t understand how the interest thing worked when we [...]
[...] Rosa and I met the criteria listed above when we bought the house we now live in. Because we were financially ready, home ownership proved to be a boon to our finances, even though Rosa had gone back to school to complete her bachelor’s degree shortly before we purchased the house and didn’t re-enter the work force for another two years. Four years after we closed on the house, we retired the mortgage. [...]
[...] of the drawbacks to prepaying the principal of a mortgage in order to pay it off faster is that it does not reduce the amount of the monthly house payment. [...]