By Michel Christodoulou
You might like to own your home, but the mortgage? Not really. In fact, you might want to do everything to pay it off as soon as possible. But is this always the best strategy?
In a sense, your mortgage can be considered “good” debt because it is backed by a tangible asset — your home — that has real value and may even appreciate in value. Plus, by historical standards, you’re probably paying a pretty low interest rate on your mortgage, so you’re getting a lot of benefits out of it – a place to live and an asset that can appreciate. And if you itemize your taxes, you may be able to deduct some or all of your mortgage interest.
However, despite these advantages, a mortgage is still something you have to pay, month after month and year after year. And for some people, it can feel good to pay it back. After all, there may well be a psychological benefit to being freed from this long-term debt. But is it really in your financial interest to make additional payments?
Suppose, for example, that you need a large sum of money quickly for a new car, a new oven or some other large and unexpected expense. Or, in an even more serious scenario, what if your job ends and you need money to tide you over until you get a new one? In these situations, you need liquidity, i.e. immediate access to available cash. And your home might not be the best place to get it.
You can apply for a home loan or a line of credit, but these usually require approvals (which can be tricky if you’re not employed), and you’ll use your home as collateral. A home equity loan or line of credit isn’t always bad – under the right circumstances, it can be a valuable financial tool. But that doesn’t change the fundamental fact that your home is essentially an illiquid asset.
So, instead of making extra payments for the house, make sure you’ve built up an emergency fund containing several months of living expenses, with the money kept in a low-risk, accessible account. After building an emergency fund, you need to weigh additional mortgage payments against other uses of your money. For example, if you have other types of debt, such as credit cards or student loans, you may want to work to pay them off faster, as these debts may also carry higher interest rates. .
You may also consider increasing your contributions to your 401(k), IRA, or other retirement/investment accounts. You could spend two or three decades in retirement, so it’s important to save as much as possible for those years.
As you can see, you have good reason to use the extra money you may have for purposes other than making extra mortgage payments. Ultimately, however, it’s a personal decision. In any case, think carefully about your choice. You may want to review the various trade-offs with a financial professional, who may be able to recommend the most advantageous strategies. And you can also consult a tax specialist. By understanding all that is involved in the “extra payment” decision, you will be better prepared to make the right choices.
Michael Christodoulou, ChFC®, AAMS®, CRPC®, CRPS® is a financial advisor to Edward Jones at Stony Brook. SIPC member.