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Alright, that's a wrap, anybody up for lunch? Okay, just kidding. So, to better understand this question let's talk about what a mortgage is in relation to your overall financial picture. Most people have two categories in their finances, those being, assets and liabilities.
But when we are talking about mortgages I don’t think they fit well into either of those categories, which is why I am an advocate for a third category called, LEVERAGE! Simply put, leverage is debt taken on to acquire an asset so that you can keep funds on hand to do other things with those funds. A great example of this is a mortgage. Mortgages are pretty awesome, they allow you to acquire large assets with relatively little down paid back over a long period of time.
Now we have some options.
We could pay cash for a house or we could use a mortgage and get a loan. If you pay cash that money is gone and has no further applicable leverage. But if you get a loan on that house, you can keep that excess cash and instead, do something else with those funds, like invest it to actually make more money. Mortgages are usually somewhere between 4 & 6 percent roughly and if you had invested in an S&P 500 index fund lets say on average you’d make around 9% per year. Soyou would actually be netting around 3-5% per year by leveraging your mortgage.
I understand this may sound a little complicated. But the general idea is that we would be leveraging our money to make more money.
Now that we have the basics out of the way lets return to the original question, should we pay our mortgage off early? Most people ask me if they think it is a good idea to kick an extra couple hundred dollars a month towards the principle of their mortgage to pay it off faster. I would say the answer for everybody is a little bit different based on your full financial profile, but in general, based on the principle of leverage I would not pay extra towards my mortgage. Instead I would invest that extra $200/mo and try to make more interest on it than I am currently being charged on my mortgage. $200 may not seem like a lot, but over time it can really start to add up. If you were in that mortgage for lets say 10 years and you invested $200/mo and made on average 9% interest, you would have over $38,000 and $14,000 of that would have been interest that you made...for literally doing nothing.
On the flip side if you had kicked the $200/mo towards your mortgage you will save maybe a few thousand in interest depending on your loan terms...and even then you can’t access any of those funds unless you sell your home or do a cash out refinance or a HELOC or some other sort of financing. I call that money being in mortgage jail and those options to access that cash, aren't free.
So in conclusion, I personally think it’s a great idea to send my money out to go and make me more money. We can use the principle of leverage to help us do that, rather than sinking our money back into a mortgage to pay it off.
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Founder of Fox Financial
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