Pay off your mortgage. Rid yourself of that debt. It’s a mantra that’s burned into the psyche of the American investor.
But it’s wrong.
The idea is bound to stir controversy, so let us explain.
If riches are what you’re after, here’s a critical piece of Know-How. It’s the simplest and most important rule in investing.
Put your money where it works hardest for you.
In other words, if you can gain 4% with one asset and 8% with an equally risky asset… go with the higher payout.
It sounds like common sense, right?
If so, why are so many mainstream investment gurus begging folks to pay down their mortgages?
It’s lousy advice.
Here’s the problem. Paying off your mortgage is not necessarily bad. It’s just that it should be at the bottom of the priority list for many investors, especially active investors who are looking for something more than just security.
If you’re looking for true, life-altering wealth, your mortgage – and the leverage it provides – is actually one of your most important financial tools.
It’s the idea of building equity that trips up so many investors.
It’s a natural desire to want to use our excess money to pay down our mortgage principal and build equity.
But the truth is you’re wasting an opportunity to put that money into an asset with much higher appreciation potential and, this is the important part, much more liquidity…
Instead of putting an extra hundred dollars toward your mortgage each month, you should use that cash to maximize your 401(k) and, hopefully, get a healthy employer match. Or you could put it in an IRA and take advantage of the long-term appreciation of stocks or bonds. Or you could use the extra cash to buy a rental property and really start building a leveraged income stream.
Put simply, the cash you use to pay down your mortgage can very likely work much harder for you somewhere else.
Points Worth Pondering
Here are the three main reasons you’re better off not paying down your mortgage.
1. Home equity is highly illiquid. Sure, it feels great to cut out that monthly mortgage payment, but your equity is doing virtually nothing for you. It’s like depositing money into an account that doesn’t pay interest and that you don’t have access to. Remember, you can’t tap that money until you sell your house or take out a loan – both will cost you money.
2. The value of your home will rise (or fall) regardless of your mortgage. The equity in your home does little to build any real wealth. No, it’s the long-term appreciation of your property that makes home ownership worth the hassle.
But what most folks don’t realize is that no matter how much you owe, your home’s value will rise and fall at the same pace. The appreciation potential of your home doesn’t change if you pay off your mortgage.
For example, if you have $200,000 worth of equity and the value of your home rises by $20,000, your return on equity is 10%. But if you have just $50,000 in equity (and are putting your cash to better use elsewhere), the same appreciation would boost your return on equity to 40%.
3. Don’t forget about inflation. Over the course of a 30-year mortgage, even today’s low inflation rates will take a bite out of your monthly payments. Right now, the spread between mortgage rates and inflation is barely more than 2% – a historically low figure. As inflation rises over the next decade, that figure means today’s mortgage provides some of the cheapest money you can find.
We haven’t always needed to shout quite so loud about not paying down your mortgage. But with the Fed working to bring rates back to “normal” levels, the effects of chasing home equity have been magnified.
For the majority of active investors, it doesn’t make sense to be in a rush to pay down mortgages. In fact, in many cases, it’s downright crazy – the result of emotional investing.
Put that money to work somewhere else.