SEATTLE NEWS ARCHIVES & FEATURES
Pay it off? Reducing loan offers guaranteed return
Jul 25, 2011, 10:12 AM | Updated: Mar 4, 2016, 5:59 am
Should you sock more cash away into your 401k retirement plan or pay down your mortgage?
Many consumers believe there is a huge benefit – financial and philosophical – to owning the roof over your head. When that roof now covers your office, as it does for millions of small business owners across the country, isn’t there an extra incentive to make a bigger dent in the domestic debt load?
Many financial planners say that homeowners don’t focus on stashing away retirement dollars until the loan on the family home is paid in full. With the cost of living, coupled with monthly mortgage payments, where do you gather extra cash to be used down the road?
According to Jack Guttentag, professor of finance emeritus at the Wharton School of the University of Pennsylvania, consumers should view the yield of principal prepayments on their mortgage as equal to the interest rate on their loan – as long as there is no prepayment penalty included in the loan. Hence, if you paying 5 percent on your loan, prepaying your mortgage would make more sense than plunking any extra cash into a savings account paying 1.25 percent interest.
Guttentag also states that if the yield on mortgage repayment is being compared to the yield on other taxable investments, it doesn’t matter whether yield is measured before tax or after tax (tax-exempt bonds could be an exception).
Would you sleep better at night knowing that you are taking a bigger chunk out of the home loan mountain rather than making a few more percentage points in other markets? Or, is the guaranteed return from prepaying the mortgage absolutely no longer acceptable given the potential of stocks, bonds and other investments?
Remember, you can save a ton of mortgage interest by prepaying your loan. In fact, if you make an extra principal payment each month, you can reduce the loan term of a 30-year loan by approximately 12 years. Conversely, by prepaying the loan, you also lose a piece of your mortgage-interest deduction. Your actual savings is computed with your marginal tax rate and your mortgage interest rate.
Are you one to dig in, do the research and then work the numbers with a broker or handle the transactions yourself? The real challenge for the average consumer is having the discipline to carry out the research. The biggest mistake many investors make is overestimating net returns over the long term.
