If you have a mortgage on your home, you’ve probably wondered at least once whether it would be worthwhile to pay it down ahead of schedule. And if so, you’re not alone. The debate over whether to prepay your mortgage has persisted in the personal finance world for some time now, and it’s not going away any time soon.
Pay Off Your Mortgage or Invest? The Math Says…
On one side of the equation, you’ve got experts who say you should not prepay your mortgage if you are locked in at a low interest rate. Their reasoning: You would be better off investing your money in the stock market where a reasonably diversified stock portfolio can expect to earn at least 7% on average over the course of a decade or more.
Add in the home mortgage interest deduction you can take on your federal taxes and, they say, you would be silly to prepay your mortgage and miss out on those perks.
To this group, the question is just about math. After all, why would you prepay a loan at 3% or 4% and lose out on part of a valuable tax deduction when you could invest that money instead and earn considerably more?
But There’s an Emotional Side to Prepaying Your Mortgage, Too
Still, there are plenty of people who ignore the math and forge ahead with their mortgage prepayment plans. My parents fell squarely in that category. Instead of taking the standard 30 years to pay off their mortgage, they paid it off in less than 20 years.
Ask them if they care about the tax deduction they missed out on, and they’ll probably look at you like a crazy person. Why? Because the decision to prepay was never about the math to them; it was about their financial freedom. And math aside, they have never regretted their decision to pay off their home and become entirely debt-free.
And a lot of people agree with that sentiment. For some people, like my parents, it all boils down to the fact that they just don’t like debt. It’s as simple as that.
But others prefer a deeper analysis.
Analyzing the Pros and Cons
For starters, let’s take a look at what the home mortgage interest deduction really means.
The easiest way to figure out your home mortgage interest deduction is to look at your effective tax rate. Say your overall tax rate is 22%, for example. On average, the home mortgage interest deduction reduces your taxes by $22 for every $100 you pay in mortgage interest.
That’s a pretty nice perk, but there’s a caveat. Your home mortgage interest deduction is only valid for the amount you deduct over and above the standard deduction, which is available to taxpayers who don’t itemize their returns. The standard deduction for married spouses filing jointly was $12,400 in 2014.
So what does that mean? Simply put, if you don’t itemize your taxes, your home mortgage interest deduction is worth nothing. And even if you do, it’s only worth what it helps you save over the standard deduction that anyone can take. In many cases, this drastically reduces the value of the home mortgage interest deduction to the point where it’s barely worth considering.
But what about those lost investing returns? When you ask people whether or not they prepay their mortgage and why, you’ll find plenty of skeptics who balk at the idea of carrying long-term debt in favor of investing their extra dollars in the stock market. And when it comes to who is “wrong” or “right,” there are several ways to look at it.
Since the stock market has performed well historically, the math favors those who choose to hold onto low-interest mortgages and invest their extra dollars instead.
However, unlike the stock market, which is not guaranteed, the interest you save by prepaying your mortgage is a “sure thing.” Many people are happy prepaying and banking the extra money they save on interest, even if it’s less than they may have earned by investing their extra dollars instead.
A Balanced Approach
As someone who loves math but despises debt, I see both sides of the issue. And that’s why my family takes a balanced approach. Our only debt is a small 15-year mortgage at 3.75%, and we choose to prepay it somewhat, but not as heavily as we could. My strategy involves maxing out our retirement accounts first and foremost and then throwing a few extra hundred dollars at the mortgage every month. I just don’t see the reason to choose between investing extra money or prepaying my mortgage, so I choose to do a little of both.
That seems like a good compromise to me. Still, there is nothing wrong with taking sides on this issue.
When you hate debt, you want to put it behind you once and for all, and that’s understandable. But it’s also understandable for someone to make their decision based solely on the numbers. After all, it’s hard to argue with math. At the end of the day, we all have to do what is best for our families – and what helps us sleep best at night.
So, should you prepay your mortgage? It is, and always has been, up to you. Just make sure any decision you make is an informed one.
Do you prepay your mortgage? Why or why not?