Why you may never want to pay off your mortgage
Here's a look at the costs and benefits of continually refinancing your home loan.
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Given record-low mortgage rates, does it make sense to ever pay off your mortgage?
No, I don't mean not making your mortgage payments, although even that can make sense under some limited circumstances. I'm referring to a strategy of refinancing your mortgage to a new 30-year loan every 10 years or so. You would then use the cash savings to pay down higher interest debt or invest for higher returns. This approach has been advocated (PDF) by financial guru Ric Edelman, but other financial gurus such as Suze Orman and Dave Ramsey recommend the opposite: paying your mortgage off as soon as possible.
So who's right? Well, as usual, it depends on your situation. Let's take a look at some of the potential costs and benefits:
How much equity do you have?
Given the recent decline in home prices, you may not have as much as you thought. This could be a problem, since you usually need to have equity to refinance at all — unless you qualify for one of these programs. Also, you generally need to have at least 20% equity to refinance without having to pay private mortgage insurance. If you're paying PMI, you may need to refinance your mortgage to get rid of it in the first two to five years, even if you have 20% or more equity, depending on the terms of your current loan. It's even worse if you have lender-paid mortgage insurance, in which case you may need to refinance to get rid of it no matter how much equity you have or how long you've had it.
How long will it take you to recoup any upfront costs?
There are several different costs to keep in mind here. First, check to see if your lender charges a prepayment penalty, generally one to six months of interest payments. If so, you may be able to get this waived if you refinance with the same lender. If not, it doesn't necessarily mean you shouldn't refinance. It's just another cost to factor into your decision.
Second, there are various closing costs that you'll have to pay upfront. These can include an application fee ($75 to $300), a loan-origination fee (can be 1.5% or more of loan principal), points (generally up to 3% of loan principal), an appraisal fee ($300 to $700), an inspection fee ($175 to $350), an attorney review/closing fee ($500 to $1,000), title search and insurance ($700 to $900), and a survey fee (up to $400). You can sometimes get "no-cost refinancing," but this just means that the lender will roll these costs into your loan or cover them and charge you a higher interest rate, so you'll pay them one way or another.
The good news is that you can eventually recoup these costs through lower payments. This calculator can help you figure out how long that would take so you can make sure you'll keep the home long enough for refinancing to make sense.
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Will you pay more or less in interest?
Of course, the main cost will be the interest rate you'll pay on the new mortgage. Because rates hit historic lows the week of June 21, you could get a lower rate after refinancing if you have a 30-year loan and haven't refinanced in awhile. However, if you're refinancing a recent 15-year loan, or if your credit has taken a hit, you may pay a higher rate. It could still make sense, though, depending on what you're using the extra cash for. This brings us to …
What would you do with the extra cash?
There are a couple of ways to free up money from a refinance. One is with lower monthly payments, either because the interest rate is lower or because you're extending the loan term. The other is with a cash-out refinance, in which the mortgage company writes you a check for a lump sum.
Here's how it works. Let's say your home is worth $500,000, you owe $300,000 on it, and you refinance with a new loan for $400,000. Since only $300,000 is needed to pay off your old loan, you can take the remaining $100,000 in cash.
- MSN Money: Should you refinance?
Keep in mind that any cash you get isn't free money. It's essentially a loan at whatever interest rate your mortgage is. While that's obvious in the case of a cash-out refinance, it can also be true whenever you extend the length of your mortgage.
So is it a good idea? That largely depends on what you do with the money. Let's take a look at some examples:
- Paying down high-interest debt. If you use a cash-out refinance to pay off credit card debt, you're probably saving a lot of interest, especially when you consider that the mortgage debt is tax-deductible. On the other hand, you're replacing unsecured debt with secured debt. In short, if you don't pay your credit card debt, your credit rating will be hurt, and there could be a small chance you'll get sued. But if you can't pay your mortgage, you could lose your home — so make sure you can afford those payments.
- Financing education expenses. One questioner wanted to use the extra money from lower payments to pay his daughter's college bills. This has less of a benefit since student loans tend to have relatively low interest rates, although not generally as low as mortgage debt. However, the refinance would reduce his risk of default since his mortgage payments would be lower, and thus easier to pay, in an emergency.
- Increasing/preserving investments. Another questioner wanted to use the savings from lower payments to contribute more to his 401(k) in the few remaining years before his retirement and then be able to withdraw less from his retirement accounts during his retirement. He would essentially be borrowing from his home to invest in his 401(k). This can work well if you're an aggressive investor and your investments perform within the historical average of 6% to 10% per year, but it also carries the risk of being stuck with additional mortgage debt, even if your investments perform poorly. The key is to make sure that you can afford your mortgage payments regardless of how your investment portfolio does.
What's your tax bracket?
As you pay down your mortgage, a greater portion of your payments goes to principal and less goes to interest. The advantage is that it gets you closer to paying off the mortgage. The disadvantage is that you get less of a tax break, since only the interest portion is deductible. Refinancing lets you restart the clock and keep a bigger tax deduction. The higher your tax bracket, the more this benefits you.
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It may be counterintuitive, but for all these reasons, continually refinancing your mortgage and never paying it off can make sense. Just make sure that you can afford the new payments, and that you'll use the savings wisely. After all, even cheap debt is debt.
The article is full of crap, I can tell by experience. I paid my mortgage in 13 years instead of the "standard" 30 years. Banks called me for refinancing three times, but I just paid two or three payments at once each month regardless of the 7% interest...I played it my way.
Today, I enjoy living in my house paying the taxes only. Even when some problems arised because the income became lower due to the economy, we never went broke because even with lesser income we still can handle it very well, buying new cars, big LCD TVs, laptops, the new iPhones, etc, plus buying good food, traveling and more...all of this because we don't pay neither rent or mortgage, and now we use all our income to enjoy other things, investing included.
My advice is to make a little sacrifice and pay off your mortgage the sooner the better, because such is the biggest headache when paying bills. By my own experience, paying my mortgage very fast has been the greatest financial strategy of my life, I can afford today to buy anything I need, to travel anywhere, have savings, and eat at restaurants and pay later on the full amount of my credit card every month.
This is REAL FREEDOM. and I'll hope for you to be as free as I am...I mean it...
With no other debts, I was able to have funds for home improvements that I didn't have to get a loan for.
I don't have, or want any credit cards. It's money you don't have, and may never have.
This article is dead wrong. Using the mortgage to payoff credit card debt is only ok if that credit card debt STAYS paid off. If you payoff the debt, and then reaccumulate the credit card debt then you're doubly in the hole.
As for the tax deduction - we are near to paying off our house (Yay!). We're also near to the point of being BELOW the standard deduction - even with interest expense. So even once the house is paid off, we'll still have deductions - while owning our home outright (Yay!)
Debt is debt no matter how you sugar coat it. Owing on anything right now (even with the mortgage rates as low as they are) is still money you are NOT earning. Manage your debt wisely obviously a lower interest rate will save you money but with an amortized loan (a mortgage, a car loan etc.) almost all of your payments in the beginning go to the interest first instead of paying down the principle. Always apply more to the principle balance to pay it off quicker. I could never advise taking out more debt to "possibly" get a higher gain in the market. Pay off your debt and stay out of this nonsense. Bottom line is your in's vs. your out's stay positive every month and our economy wouldn't be in the state it is in right now. It is not about how much money you make, it is about how you manage it.
RRR1, you're an idiot.
How can you say that my advice is bad? Everything about what I said is geared towards the home owner being mortgage free as soon as possible, and paying less interest over the life of the loan. Note that I also said "only if the savings are significant and the break even point on closing costs is brief." If someone can refinance to a 15 year fixed at 3% with no points, and pay about $2,000 or so on third party fees, and the net result is that they have their home paid off 10 years earlier than what they're on track for and save tens of thousands on unnecessary interest while making a similar payment, how is that bad advice?
I analyze this every day as a career. I absorb more financial savvy and acumen (I'll wait while you look those up in the dictionary) on accident than you do on purpose. You, sir, are an ignorant puddle of afterbirth.
Our parent's and grandparent's bought a home, within their means, paid it down and sold it when it was time. It wasn't until the mortgage industry became "creative" with little oversight that the nation ended up bent over a table. Banks now own many American homes and gave themselves substantial bonuses paid with American tax dollars. Many American's are now jobless and left renting due, in part, to the damage their greed had on the most powerful economy in the world. Are you really going to trust the advice from anyone in the mortgage / banking industry? Stick with basics .
Want to know why brokers think this is a good idea. Do the math = 2000 ave refinace cost x 50 homes a year = 100,000 for processing a refinance. umm 1 a week. What a joke
Of course if you are planning on staying in your home - get rid of the mortgage - and here is how to use the benefit of not having a mortgage...
Pick out an early retirement age, some age where you need to fill in the gap to 'normal retirement age'. Count back 8 to 10 years from that. This should be your mortgage pay-off date. Then, take the principal and interest that you WOULD HAVE been paying to the bank and pay yourself - as if you had not paid off. Let that grow for 8 to 10 years, retire, and let that get you to your regular retirement age.
Best gift you could give yourself - a home that no one can take away and the freedom to retire early and enjoy life a little bit more just a little bit sooner.
If you need to refinance to pay down credit card debt or other higher interest debt - that is a screaming red flag you are living way beyond your means. Don't continue the vicious debt cycle, instead, honestly reevaluate your situation.