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« Team: New Venture Update 20 December 2012 | Main | Team: A New Venture for Your Consideration »
Wednesday
Dec192012

When to Pay Off Your Mortgage

My good friend Rob recently paraphrased Warren Buffett as saying, “If he knew where he was going to live for the next decade, he’d buy a house with a long-term mortgage.” Buffett thought a mortgage was a good hedge against inflation, because the homeowner would pay off the mortgage with cheaper dollars down the road.

My own mortgage caused great conflict between the emotional and logical sides of my brain. When I was contemplating paying it off, I spoke with a financial counselor and explained that I was self-employed and my mortgage was my largest monthly payment. I suggested paying it off to eliminate stress. He pooh-poohed that idea, and insisted that I could easily earn more after taxes than the cost of a first mortgage.

I asked if his mortgage was paid off. He looked at me and said, “Oh hell yes!” I was flabbergasted. How could he advise me to do one thing when he’d done the exact opposite? He explained that his wife was from Germany – the old school where you pay your bills and keep out of debt. Were it not for her, he’d gladly have a mortgage.

When my son purchased a new home, I suggested he ask the lender for an amortization schedule, a report showing what portion of each payment will go toward the principal and what portion is interest. He was shocked to realize well over 90% of his payment was going toward interest. It wasn’t until the last five years of his mortgage that the bulk would be applied to the principal. Everyone with a mortgage should pick up – and read – an amortization schedule from the lender so one knows exactly what portion of each monthly house payment actually reduces one’s mortgage.

Paying off your mortgage does change your life. You sleep better, and I imagine my blood pressure dropped ten points. I’ve never met anyone who regretted paying off his mortgage. Once we made the decision, we never looked back.

However, I readily admit that my emotions prevailed in my decision to pay off our mortgage. In an effort to give both sides of the argument, Vedran Vuk, lead analyst for Miller’s Money Forever, has shared his thoughts on when it makes solid financial sense to invest elsewhere and not pay it off. He makes some excellent points…

When Not to Pay Off the Mortgage

By Vedran Vuk

Dennis’ financial counselor gave him standard mortgage advice, but he left out some important factors. If investors can earn a greater after-tax return elsewhere with minimal risk, they should do it rather than paying off their mortgage. Over the last 30 years or so, you could safely expect 10% annual returns on the stock market, and at worst, market crashes were short-lived and stocks recovered in no time.

Unfortunately, we don’t live in that world anymore. Investing is now filled with worry and anxiety. Next year, the market could rise 10%, or it might drop 40% and stay there. Paying off your mortgage is a guaranteed way to save money. Putting money into the stock market is not.

Since the market is still shaky and bonds are paying close to nothing, it makes sense to make a few additional mortgage payments. But suppose the clouds over Europe and the rest of the world economy disappear – then it might be wise to put a little more money into the market.

However, another scenario is much more likely: rising interest rates. If interest rates rise in the next few years, paying off your mortgage would be a mistake. If you can earn 6% or 7% on US Treasuries or AAA-rated corporate bonds, paying off a mortgage locked-in at 3.25% is clearly not a rational decision, because these investments carry minimal risk.

If you can earn a higher return than your mortgage rate with limited risk, don’t pay off your mortgage. But if bond yields are pitiful and market risk doesn’t justify the return, stick to enjoying the emotional comforts of paying down your mortgage.

Whether you’re considering paying off your mortgage or not you’ll want to make sure this works within your retirement plan objectives. Click here to heck out my short letter on how to start your plan or just get a “second opinion” on your current plan

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Reader Comments (1)

All good points.. The other factor is cash flow... what if you lost your job for a year ( or got in accident and couldn't work, or someone in your family needed $100K medical treatment) .. all this can take liguid assets. It is important to keep enough liguid assets (cash) to cover your needs for at least a year. So, if your cash flow is too tight, it might make sense not to pay off the mortage but instead to build up liguid assets. There are lots of good businesses that go under because they don't maintain enough cash flow, and get in over their head -- run into trouble and end up going under. The same can happen to people. If you have good mortage, then usually at specific times, you can take any any extra money and put it to the mortage, meanwhile, keep and build up a healthy nest egg of liguid assets... it could be life saver. On the other hand, the danger in not paying down the mortage is that you aren't building the liguid assets (and generating income), and it just puts ones finances in greater risk. Also there is the temptation to buy things.... you can't afford. My suggestion is keep year's worth of expense money in liguid assets, use the rest to pay down your mortage. Bottom line is don't buy a house if you can't keep a year's worth of cash flow in reserve.
Catch 22: If you have the money -- you don't need pay off the mortage, if you don't have the money you cannot afford to - even though you should.

December 20, 2012 | Unregistered CommenterClifford

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