Your Mortgage: Maintain, Refinance, or Pay-off?
It seems every local paper, financial network, or informative media source is reporting about historically low interest rates, the fear of zero or negative interest rates, and the discussion of stagnated economic growth because of these conditions. What does all of this mean for you as a homeowner?
The current low-interest rate environment has heralded an unprecedented opportunity for homeowners to reconsider the much-regarded theory that owning their homes free and clear of a mortgage is the harbinger of long-term financial security.
What is a homeowner to do? Owning a home is indeed a quintessential goal of most individuals. We have entered an era with the current low-interest rate environment where there may be merit for some homeowners to consider refinancing their homes to take advantage of these low interest rates as part of their long-term financial plan. These decisions should be made on an individual basis after a thorough analysis with a qualified financial professional.
Before you start thinking we have lost our minds and that there is no way you would attempt to refinance or maintain a long-term mortgage, let’s take a look at some of the benefits of holding a mortgage.
HISTORICALLY LOW MORTGAGE RATES:
Many individual investor financial goals include home ownership free and clear of mortgage debt. However, I think we can all agree that low mortgage interest rates can benefit homeowners who qualify for these low rates.
No debt ideology:
First, we need to understand why the ideology of paying off a mortgage originated. If we look back in history to the late 1920s and 1930s, we are reminded of an unfortunate time where a large number of families lost their homes. Fear was engrained in Americans because of this and, in turn, the desire to buy and keep a home became a defining way to achieve financial security. As we move forward in time and look at the late 70s and early 80s, we see mortgage rates as high as 15-20%, which made homeownership unmanageable for many families. Due to these economic experiences, our parents and grandparents made it a point to encourage their children and grandchildren to pay off a home to ensure long-term financial security.
Reduce monthly payments and cash flow obligations:
Many people try to eliminate their mortgage to get rid of the pesky monthly payment thinking they will have an increase in monthly cash flow. Even though the mortgage is paid, money still needs to be set aside on a monthly basis for property taxes and insurance. So, a good portion of a monthly “mortgage payment” still exists.
Mortgage Tax Deductions:
When a home mortgage has been eliminated, the tax deduction for mortgage interest is no longer available come income tax time. The mortgage interest portion of a mortgage payment is tax deductible in most circumstances. This means that a percentage of the mortgage payment you pay each month decreases your taxable income. This is one of the largest upsides to maintaining a mortgage throughout your lifetime. A simple mathematical calculation and analysis with your tax professional can help you determine the cost-benefit of having a mortgage interest deduction.
Liquidity and Opportunity Costs:
There is a liquidity and potential investment benefit to having a mortgage. Typically, a home is an individual’s largest asset. Therefore, compared to other types of debt, mortgages hold the lowest, tax-adjusted, interest rate for the largest portion of someone’s net worth.
If individuals are disciplined and utilize their cash-flow and assets optimally, great benefit can be achieved from having a 30-year mortgage. To illustrate a hypothetical example:
Let’s say an individual purchased their first home for $200,000 and made a down payment of 20% (or $40,000) with a 30-year mortgage for the remaining $160,000 at 4% interest. Ten years later, this same individual gets married and decides to move into a bigger home to accommodate an expanding family. At 4% appreciation in the original home’s value, the home would now be worth $300,000 and have approximately $180,000 in equity. If they purchase a larger home for $400,000, with a 20% down payment of $80,000 and put the remaining $100,000 to work in a tax-efficient, balanced portfolio, the following could hypothetically result.
The $100,000 from the initial home’s equity could be invested in a tax-efficient, balanced portfolio, providing the growing family with liquidity and emergency reserves that would not otherwise be available if the funds were tied-up in their home. A home is not a liquid investment and money you have invested in your home earns a 0% rate of return. Whereas, a tax-efficient, balanced portfolio has a greater opportunity to produce returns greater that 0%. Add in the tax benefit of deducting the interest, and things really start to get compelling for the rationale of holding a 30-year mortgage.
Hypothetically, $100,000 in the S&P for 20-years would provide an approximate 10% return on your investment, resulting in $492,60.28 in an outside investment account that is accessible to the family.
Once you have put money down or paid-off your home, the only way to get it back is by selling your home. This means the largest portion of your net worth is not accessible and not working for you the way it could potentially be in a tax-efficient investment account. Additionally, the benefits of utilizing the mortgage interest deduction would be reduced or eliminated as well.
As another example: Retirees may be desiring more liquidity to provide resources for travel or just plain enjoying their freedom in retirement. If they choose to “downsize” as many do, by re-deploying the equity from their home sale and getting a mortgage for their new home, investing that equity in a tax-efficient manner, spinning off dividends and interest for travel and for enjoyment with the goal of preserving the principle for potentially paying off a home at a later date, the retiree has accomplished many objectives. They have freed-up some liquid cash for travel, they are investing money for a hypothetical 20-year retirement and utilizing the proceeds from that investment (dividends and bond yield) for extra cash-flow. With the goal of having a “capital preservation model allocation,” the equity from their home-sale could be potentially preserved to pay-off their home down-the-road should they choose to do so.
Factors to Consider:
A lot of factors need to be considered when evaluating strategies for home ownership, especially income and cash flow throughout a lifetime. The ideology of buying a home and paying off the mortgage has become an antiquated way of thinking due to the current low-interest rate environment.
We think taking time to explore ways to take advantage of historically low interest rates is a good use of time. The changes in your monthly mortgage payment could potentially increase your liquidity, ability to save, provide the ability to invest in a pre-retirement savings or investment account, and potentially provide access to liquid assets for other opportunities that are unforeseen at this time.
We suggest you call your current lender as well or get a second opinion from a mortgage broker to see what options may be available to you. If you are in need of a reliable referral to meet your refinancing or purchasing needs, please feel free to contact us for a list of trusted providers.
We strive to be in position to help answer these kinds of questions and bring you up-to-date information. We enjoy working as a team with other trusted advisors such as your tax accountant or estate planning professional to bring you a multi-disciplinary approach to the decisions that impact your finances.
Please be in touch if you would like additional information or to schedule a consultation to see how a taking a look at your current mortgage could benefit you and your family.