NEW YORK, NY – (April 7, 2011) Clearlease.com Reports Clients often ask if they should pay off their mortgage with their savings or take that nest egg and put it to work in the market. My answer: It depends, but in today’s interest rate and market environment, I would likely suggest investing.
Yes, your house is an appreciating asset, but it is not appreciating as quickly as it once did, which may be true for a long time. The credit markets are generally dried up and it takes free flowing credit for the real estate market to boom, a phenomenon that may not happen again in our lifetimes.
Let’s examine the question more closely assuming the following:
–You have a $500,000 home.
–Interest rate on your mortgage is 5 percent.
–Return on investment is 8 percent.
–Return on real estate value is 5 percent.
–Tax rate is 25 percent total.
–You have the money to pay off the loan in non-qualified (taxable) assets.
Scenario 1: You pay off your mortgage. Since there is no loan, and no investment other than your house, both your investment money and your house value increase at 5 percent (the rate of return on real estate). Your total increase is $25,000.
Scenario 2: You owe $450,000 (90 percent of your home’s value). In this scenario, you have a $450,000 note with a 5 percent interest rate. The cost to you is $22,500 per year in interest. But since you are able to deduct the interest on the note, the real cost, assuming a 25 percent total tax rate, is $16,875 per year.
Remember, you will also have the $450,000 that you would have used to pay off your mortgage invested. Assuming the above 8 percent return on investment, this will give you a return of $36,000. Net out what you make and what it costs–$36,000 less $16,875–and you earn a $19,125 return each year.
Keep in mind that your real estate will be increasing in value as well. In this case, even though you only own 10 percent of the house, or $50,000, you may be thinking that your increase will be $50,000 at 5 percent. But the real story is that the entire value of your home is increasing at 5 percent, making your gains equal to $25,000. That means your entire increase (in year one) is $19,125 plus $25,000 which is equal to $44,125.
All in all, you are $19,000 ahead of the game by not paying off your house, and that’s just looking at year one. While the numbers change for subsequent years, the principles remain the same.
Two things to keep in mind: It’s very important to have investments capable of achieving an 8 percent return, and make sure to use tax-deferred investments so the compounding effect is greater.
This concept works very well, but only in a low interest-rate environment. The lower rates are, the more it may make sense to hold a mortgage and invest your dollars. But as rates climb higher, it may make sense to pay off that debt. There is a calculation you can do based on your rate of return and rate of interest, but at around a 7 to 8 percent interest rate it begins to make sense to start paying off principal.
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About Dominion Lending Centres Clearlease
Dominion Lending Centres Clearlease Commercial (DLC Clearlease/Clearlease.com) is a fully diversified Lease Finance Mortgage Banking Brokerage Company specializing in Equipment Leasing, Automobile Leasing, Residential, Commercial Lending/Mortgage Financing. DLC Clearlease possesses the capability to accommodate financing needs ranging from a small second Home Mortgage to a Multi-Million Dollar Commercial Projects. No mortgage is too small or too large for this integrated Company.
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