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Money Magazine Takes on Six Financial Dilemmas
By JLP | December 12, 2007
There’s an interesting piece in the January, 2008 issue of Money. The article, Make the Right Call, addresses six financial delimas that most of us face at one point in our lives. The dilema that interested me the most was the one subtitled “Prepay your Mortgage OR Invest.” Long-time readers of this blog already know my thoughts on this topic because I have blogged about it numerous times (the related posts are listed at the bottom of this post). Here’s Money’s take:
Prepay your mortgage OR invest
The feel-good choice isn’t necessarily the smart choice.
When some extra cash comes your way, it’s tempting to put it toward your mortgage. You’ll save on interest and pay off your house earlier. Buying stocks, on the other hand, feels like a risky leap into the unknown, especially now.
Strictly by the numbers
Paying off your mortgage or any loan is an investment, and your return is essentially the interest rate on the loan. If you have 25 years left on a 30-year mortgage with a fixed rate of 6.2 percent and you deduct your interest payments on your taxes, you’ll earn 4.5 percent by prepaying the loan (assuming you’re in the 28 percent tax bracket).
Now let’s say you invest your spare cash in stocks instead. You’ll pay a 15 percent tax rate on your long-term capital gains and dividends. So to beat the 4.5 percent return you’d get from prepaying your mortgage, you’d have to earn just 5.3 percent a year on your stocks before taxes.
The odds of your doing that over the 25-year remaining term of your mortgage are excellent: Historically, a portfolio of 80 percent stocks and 20 percent bonds has returned 7.5 percent a year after taxes.
But wait
Paying down the mortgage earns you a risk-free 4.5 percent. That’s as good as you’ll do with Treasury bonds. True, and if you are investing for a near-term goal and don’t want to take any risk, you can make a stronger case for prepaying your mortgage. But if you are investing for a goal that’s more than a decade away, you can and should take more risk for a chance at a higher return.
You do the math
To run the numbers on how much money you could end up with by investing, use the savings calculator at CNNMoney.com. To see how much interest you’d save by prepaying your mortgage, use the payoff calculator at Dinkytown.net.
Beyond the math
Of course, all that mortgage debt may be keeping you awake at night, especially if you are worried about losing your job or you’re approaching retirement and hope to live on less. You’d be grateful to be rid of that major monthly bill sooner. In that case, prepaying your mortgage starts looking better.
Remember, though, that by prepaying your mortgage, you are reducing your liquid assets. If you suddenly need money, it’s easier to sell a mutual fund than it is to pull cash from your home, and you can always pay off your mortgage later with the money you invest now.
The bottom line
Investing wins.
Interesting. Oh, and in case you’re wondering, I didn’t post this just because it basically agreed with my opinion.
I urge you to go read the rest of the delimmas in the article. It’s an interesting read.
Now here’s some related posts that you might find interesting:
Which is Better: a 15-Year or 30-Year Mortgage?
Ever Wonder What a Mortgage Amortization Looks Like?
How an Interest-Only Mortgage Works
Check Out the Latest Dave Ramsey Poll - The topic was mortgages.
A Follow-up to the Dave Ramsey Mortgage Post - This is Interesting
10 Great Reasons to Carry a Big, Long Mortgage
The Mortgage Deduction and Taxes
Should You Prepay Your Mortgage? - This was a popular question of the day.
How Much House Can You Afford?
Topics: Mortgages |
