May 12, 2009

By Andre Plessis
Should You Own Your Home Free and Clear?


This is a very tough question to answer. There are many factors to consider before answering this question. For example, how much money do you have in retirement assets, such as pension or 401(k) plans? What is your current mortgage balance? What are your plans after retirement? Will you be spending a lot of money once you no longer have a full time job?

Debt management discussions often start with home mortgages, which are the most common loans among financial planning clients. For example, should you buy real estate for cash or use a loan? External factors can make a difference.

Should you pay down your mortgage? If you have a 6% mortgage, paying down the mortgage generates a 6% return-and after counting the tax deduction, will typically produce a return of around 4%.

The maneuver often makes good sense, despite the loss of liquidity. You may have large amounts of money in accounts paying little yield. Using that cash to pay down home mortgage debt will produce a significantly higher return" than the account.

Of course, cash-heavy clients have other options besides prepaying their mortgages. Investments in equities and perhaps fixed income could yield annualized returns higher than 4%, after tax, starting from today's low asset values.

Besides prepaying, homeowners can refinance existing mortgages to reduce monthly obligations and boost cash flow. As of this writing, Bankrate.com put the interest rate on a 30-year, fixed-rate mortgage at 5.19%-the lowest since December 1956.

I am not a believer that homeowners should have a house "free and clear" of any mortgage debt. There are too many elderly people who are, unfortunately, "house rich and cash poor." Their house is worth a lot of money, but they do not have the cash necessary to maintain the house, let alone enjoy their golden years.

Those people did not understand that there is a big difference between eliminating debts and building wealth. You can't really do both at the same time, as the proverb says it so well: "The Man Who Chases Two Rabbits Catches Neither."
– Confucius, Philosopher

If You Put Your Efforts And Energy Into trying to Fulfill Two goals at The Same Time, You Won't Succeed in Either One.

Let us assume that your house is now worth $600,000, and you still owe $40,000. Since your mortgage is only $40,000, your equity in the house is $560,000.

While no one can predict the future, I am almost confident that real estate will continue to appreciate over the years, although not as dramatically as it has done in the past few years, as real estate was appreciating at 15% per year as opposed to a normal 5%  appreciation.

So regardless of how much equity you have in your house today, it will probably continue to appreciate year after year. The equity you have in your house is doing absolutely nothing for you, except perhaps giving you some peace of mind.

Many people, especially when interest rates are currently so low, are refinancing, and pulling out some of this equity. For example, if your house is worth $600,000, you can get a loan of up to $480,000 (i.e. 80 percent).

This money is not taxable in any way to you; it is your own money that you are taking out from your home equity.

Clearly, I do not recommend borrowing money at five or six percent merely to put it into a savings account, which will only pay you one percent to two percent in interest. Nor do I recommend that you speculate in the stock market. You worked hard to build equity and should not gamble with your money.

However, there are many safe investments that competent financial advisors can recommend with low risk that will also offer more liquidity. And since everyone is convinced that mortgage interest rates will increase later this year, that also means that investment (savings) accounts will also increase.

So if you want to pay off your low mortgage balance, because you want to get rid of your mortgage I would not recommend that solution. Take any extra payment and invest it somewhere else. Don't put all your eggs in the same basket.

What is the point to pay off your mortgage if you have not built sufficient wealth to maintain a certain lifestyle during your golden years?

You'll then take a reverse mortgage, which will cost you a lot of money upfront, you won't be able to deduct your reverse mortgage, because it is not, and you will start losing all the equity you built.

There is better strategy than paying off a mortgage, which is to build wealth, using your mortgage, which is the lowest money you can ever borrow. It won't be difficult to find strategies to yield a better return than a mortgage that is a tax deductible tool to you.

Do your homework carefully. Try to determine exactly how much money you will need in retirement before you make the decision to pay down your mortgage. Once it is paid down, it will be well too late to build wealth.