It seems every local paper, financial network, or informative media source is reporting about the historically low interest rates, the fear of near zero or negative interest rates, and the discussion of economic growth because of these conditions. What does this really mean and more importantly, what does it mean to you?
Historically Low Mortgages Rates
Current low interest rates have created an environment where the old ideology about mortgages no longer applies. In the past, our financial goals included homeownership free and clear of mortgage debt. We have entered an era where we now suggest you refinance and maintain a mortgage for the rest of your life, or at least to a 30-year mortgage term. I think we all can agree that low mortgage interest rates benefit the homeowners that own a mortgage and qualify for these low rates. Before you start thinking we have lost our minds and there is no way you will attempt to maintain a long-term mortgage, let’s take a look at some of the benefits of holding a mortgage. (For related reading, see: The Pros and Cons of a 30-Year Mortgage.)
Why We Think We Should Pay off Our Mortgages
First, we need to understand where and why the ideology of paying off your mortgage comes from. If we look back in history to the late 1920s and 1930s, we are reminded of a time where a large number of families lost their homes. This fear was ingrained in Americans and, in turn, the desire to buy and keep a home was a defining goal of financial success. We move forward to the late 70s and early 80s and we see mortgage rates as high as 15%-20%. Due to these economic and emotional experiences, our parents and grandparents made it a point to teach their children and grandchildren that paying off your home is a necessity to ensure homeownership.
Reduce Monthly Payments
Although this is a great concept in theory, does it still hold true today? The answer, quite frankly, is a resounding no. The main reason people try to eliminate their mortgage is that pesky monthly payment. Let’s say you bought your home with a 30-year fixed mortgage and paid every month on time without refinancing. The month after your last mortgage payment, you still have to make a payment on your house. This time you are paying your taxes and insurance. What was once conveniently saved monthly for you by your bank or lending company is now your responsibility. Thus that pesky monthly payment you tried to alleviate continues. It is proven that an affordable mortgage payment helps individuals and families run and maintain a personal financial budget. It just helps everyone plan and maintain a financially healthy mindset.
Mortgage Tax Deductions
In addition to still having to pay this monthly payment, you lose out on the benefit of having that money help you come tax time. One thing to remember about your mortgage is that the payments are tax deductible. This means that a percentage of the money you pay each month decreases your taxable income. This is one of the largest upsides to maintaining a mortgage throughout your lifetime. (For related reading, see: Tax Deductions on Mortgage Interest.)
Maintain Investable Liquidity
There is also a liquidity and investment benefit to owning a mortgage. The most beneficial is that a mortgage is one of the most inexpensive loans you will ever have. Compared to most other forms of debt, mortgages hold the lowest interest rate for the greatest amount of money. This cheap money provides some benefits when you either refinance or purchase a new home. The money you earn from selling a home or refinancing a home that has increased in value can be used to invest in your retirement or another account. This will allow you to grow your wealth quickly and at a very minimal cost to you. This will allow for diligent saving and all the equity accrued from the home can be used for the next stage in life and improving liquidity needs.
Let’s look at an example. Let’s say you purchase your first home for $200,000, make the down payment of 20% ($40,000) and have a 30-year mortgage for $160,000 at 4%. Ten years into that mortgage, you get married and you and your spouse decide to sell your home and move into a bigger home to accommodate an expanding family. Your home is now valued at $300,000 with $180,000 in equity. You purchase a new home for $400,000. How much do you put down? We suggest that you put 20% down and invest the remaining $100,000. Saving this money can increase your emergency reserve savings, your retirement assets and enhance your overall financial security. If you stay diligent and use the monies for these purposes, you always have the ability to pay off your mortgage in the future if you so desire. You have created a cash flow of liquid and easily accessible money (e.g. if you invest the $100,000, for 20 years at a rate of 8%, less than the historical 20-year average of the S&P 500 of 10%, your investment account balance would be $492,680.28 and your mortgage balance would be $132,958.72).
Once you have money invested in your house, the only way to get it back is by selling your home. This means if you have a home with $400,000 in value and equity, the only way you can get at the equity is to sell your house. If you sell your house, where are you going to live? Typically, when homeowners change housing situations through events such as downsizing, they swap their current home’s equity to purchase the new home, never utilizing the home’s equity in the most advantageous and tax beneficial manner. (For related reading, see: The Smartest Way to Tap Your Home Equity.)
The ideology of buying a home and paying off the mortgage has become an antiquated way of thinking due to the current low interest rate environment. Explore refinancing your home to take advantage of historically low rates. The changes in your monthly mortgage payment increases your savings, liquidity and your retirement funds long-term, which allows you to retire sooner and reduces the taxes you pay to Uncle Sam.
(For more from this author, see: The True Value of a Financial Advisor.)