Home no loan: Should you pay off your mortgage early?

Published: Tuesday, May 7 2013 11:40 a.m. MDT

It isn't easy to decide to pay off a mortgage early or to invest that money instead. Just comparing the interest rate on the loan versus a projected interest rate on an investment isn't enough. People have to watch out for mortgages that have pre-payment penalties where they charge a penalty for paying early or paying too much within certain time limits. Other factors include the mortgage tax deduction and how much interest a person is still paying versus principle. A person could also get a deduction by paying the house off early and then, instead of paying thousands in interest to a bank, pay that money to a good cause and get a deduction that way.

This is what Cohen, a principal at Anthorne Group PR and founder of CustomerOnBoard.com, says she did.

After Cohen sent off that last check at the post office, she felt free to do more with her money.

"A staggering amount of the total cost of the house is interest," she says. "I don't know why people don't look at that. When you think about it, there are a lot of better ways to invest your money than in interest. If you want a deduction, take the money and put it to a good cause. Then you feel good about it and get the charitable deduction instead of paying interest to the bank, which really benefits nobody."

Emotion and math

Tresidder, the founder and financial coach at Financialmentor.com, isn't as demanding about not paying off a mortgage these days, even after losing a fortune paying off his condo. He wrote an article on the subject and determined that there are two big answers to consider when deciding whether to pay off a mortgage early.

"There is no right answer," Tresidder says. "There is the mathematical answer and the emotional answer."

The mathematical answer is people should do whatever gives them the highest return. Which would mean, he says, that people would rarely pay off their mortgage early. "If you have a mortgage at current interest rates of say 4 or 5 percent, odds are the long-term return from investing, unless you are very incompetent, will exceed that," he says.

But life isn't that simple because there is also the emotional answer.

"The assumption that we all value maximum mathematical expectancy from our money is not true," Tresidder says. "We have all kinds of different emotions tied to our money. We have all kinds of different goals. And for some goals it makes sense to pay it off early, for others it does not."

If, for example, people's primary goal is security, Tresidder says getting out of debt is a good idea. "So in that sense, it makes sense to pay off the mortgage early," he says.

This means the answer is different for different people. If the goal is maximum wealth, the analysis of the situation is going to be different than if the goal is maximum security.

But even if someone has the goal of paying off the mortgage early, that doesn't necessarily mean that goal should trump all other financial goals.

First things first

Tresidder says other more important goals could include maxing out a 401K plan at work. "Some companies offer a 50 percent match on that 401K," he says.

That is an automatic 50 percent return on an investment.

The same approach should be taken with other retirement plans.

High-interest debt also should be paid down first such as credit card debt.

The danger of paying off a mortgage early is that the money becomes illiquid, tied up in the house. In an emergency, a person may be forced to get a loan to get that money out of the house. This is one of the main dangers Ailion and Rae were concerned about.

This is why Tresidder and other experts recommend keeping three to six months of cash in a liquid, easy-to-access emergency fund.

Tresidder doesn't want to pay off his mortgage early, because he can get a higher investment return. But, on the other hand, he doesn't want to pull equity out of his house to increase his investment capital either. "You can't have it both ways," he says.

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