It’s easy to look at your 30-year mortgage as a financial ball-and-chain that forces you to cough up x amount of your paycheck every month, limiting your ability to take that getaway to Cancun. You can make your mortgage much more malleable, however, by taking advantage of historically low interest rates as well as options that will help you pay off your mortgage years earlier than its maturity date.
Pay it down or not?
The most effective savings/investment plans are often those we can do without thinking. An example of that is the biweekly mortgage payment plan.
If you split your monthly mortgage payment in half and make that half-month payment every other week, you will end up with an extra monthly payment per year.
“If you are on a 30-year mortgage and make one extra payment a year, you can shave off six years on a 30-year mortgage or three years on a 15-year,” said Amy Loerzel, loan consultant at imortgage in Lisle.
Low interest rates are changing the conversation, however. Is it worth paying down a mortgage when the interest is only 3.75 percent and you’re able to get tax credit for the interest paid, or is it better to invest that money into equities that could produce a much higher rate of return?
“I definitely see merits with both,” said Charles F. Millington CPA, MBA, CFP® of Millington Financial Advisors in Naperville. “It depends on an individual’s capacity for risk.”
“If you have the ability and discipline to invest and you feel comfortable that you can invest in a manner that will outpace what you pay in the interest rate on your current mortgage, it makes sense to keep some of that money out there,” said Millington.
Millington’s clients are almost evenly split between those who would pay it off early and those who will invest it instead.
The pay-down group usually is preparing for retirement—often 10 to 15 years out—and making sure they don’t have a mortgage obligation when their take-home income declines.
“Others think they can do better in the market. They have a historically low mortgage rate and like the flexibility of liquid investments,” Millington said. “They’re not necessarily dedicating all their resources toward debt obligation.”
The latter group includes people who expect to have a strong pension, so they can afford to pay for their mortgage after they retire.
Instead of being tied to a conventional 30-year mortgage for your home, low interest rates are making other options—such as 20-year and 15-year—attainable for homeowners.
If you’re keeping the same term, the trick is to make sure the difference in interest rate is worth it—an eighth of a point is not because it will take too long to recoup the closing costs, Loerzal said. If you have a difference of 0.5 percent or more, or a shorter term, you’re more likely to save money.
Homeowners who are still paying mortgage insurance can benefit as well by showing the bank that they have reached the 80-percent threshold to remove the insurance.
“Interest-only loans might be an option for families that know they’ll be in a home for just a couple years,” said Loerzal. But those loans can become a problem when they switch to interest and principal years later and can affect cash flow, Millington said.
The bottom line is that investing in a house might be expensive, but the costs today are relatively low compared to past years.
“I’ve always said housing is the one investment you get to enjoy while you own it,” Millington said. “Stocks, bonds—you’re not able to get any real benefits except an income stream. You get to live in a house and there is an inherent benefit to having a roof over your head.”