“Should I pay off my mortgage as soon as possible or not?” is a common question that many real estate investors wonder about. How do you decide?
The answer is pretty simple actually. You should pay off your mortgage sooner if you have the money. By the way, the sky is blue. Thanks for nothing, you’re thinking. However, if you really think about it, that’s the right answer!
It’s all about balancing your debt/cash ratio. Build up too much home equity (prepaying) based off of your own principal payments, and you run the risk of blowing yourself up when there’s a cash crunch due to unforeseen circumstances.
Your conservativeness of paying down your mortgage ironically INCREASES your chance of financial doom. Not paying down your debt sooner, on the other hand, inhibits you from maximizing your returns. Dance with your mortgage without stepping on its toes!
Three Variables To Consider Before Paying Down Your Mortgage:
1) Interest Rate Differential
Should I pay off my mortgage? If your mortgage interest rate is more than 4% of your savings interest rate (i.e. 6% mortgage and 1.5% savings rate), try and throw as much money as you can comfortably afford at your mortgage.
Remember, you pay taxes on your interest income, so the tax deduction on the mortgage interest is a wash. 4% is the critical spread, because 4% should also be your expected risk free interest return on your retirement portfolio. By paying wider than a 4% spread, you’re hurting yourself in the long run.
2) Money Choices
If you have nothing else better to do with your money, and feel secure about your job, pay down your mortgage as much as possible. Every dollar you use to prepay your mortgage returns you your mortgage interest rate.
In my case, prepayment earns me 5.25%, a 4% spread over current savings rates. You may want to consider using your HELOC to even pay down your primary mortgage principal thereby arbitraging rates.
3) Duration of Stay
Still wondering, should I pay off my mortgage? If you plan to live in your house less than 5 years, do not pay down your mortgage. The more cash you sink into your house, the more illiquid you become.
What if a hurricane blows away your house, then what? Since the plan is to sell the house within 5 years anyway, what on earth are you doing risking your cash flow?
Furthermore, you probably shouldn’t be buying a house in the first place with under a 5 year holding time frame due to the 5-6% transaction exit fee.
Should I pay off my mortgage? The best way to deal with your mortgage is to make extra principal payments with money you will not miss. If you don’t have at least 10% of the value of your property in cash savings, forget about pre-paying as well.
Consider pre-paying your mortgage as a luxury, which you can only afford when you are flush with cash. Every time you stop into your mortgage bank, pay down some principal.
Even a couple bucks here and there add up over the long run and you won’t even know it. You never know when financial hardship will hit, so best to variably pay down debt as you go.
Shop Around For A Mortgage
Check the latest mortgage rates online through Credible. hey’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible.
This is exactly what I did to lock in a 2.375% 5/1 ARM for my latest refinance. For those looking to purchase property, the same thing is in order. If you’ve found a good deal, can afford the payments, and plan to own the property for 10+ years, I’d get neutral inflation and take advantage of the low rates.
Explore Real Estate Crowdfunding
If you’re looking to buy property as an investment or reinvest your house sale proceeds, take a look at Fundrise, one of the largest real estate crowdfunding platforms today.
They allow everyone to invest in mid-market commercial real estate deals across the country that were once only available to institutions or super high net worth individuals.
Fundrise is the pioneer of eREIT funds and they are creating an Opportunity Fund to take advantage of tax-efficient Opportunity Zones. Thanks to technology, it’s now much easier to take advantage of lower valuation, higher net rental yield properties across America.