A Conversation in what Paying off your Mortgage Does and Does Not Achieve
A CoCreate Financial Article by Christa Hudak
There are a lot of opinions swarming around the world about financial matters and a plethora of places to turn for financial advice. One prevalent conversation that frequently comes up is the belief that paying off your mortgage and owning your residence free and clear is a key step toward financial freedom. While it is obvious that having less debt and more assets is a good thing, the problem comes when the concept is simplified to Mortgage Free = Financial Freedom. Let’s take the time to explore what paying off your mortgage does and does not accomplish for your financial situation.
Your Mortgage Payment is More than Your Mortgage
There is no question that housing expenses are a sizeable chunk of most people’s monthly budgets and is frequently the largest bill that a person pays. The idea of eliminating this payment sounds like a great way to free up cash flow or allow yourself to live on less. The first point that is critical to remember is that generally, your mortgage payment includes more than your mortgage. It’s likely that about a third of your mortgage payment is going to an escrow account to pay your home insurance premiums and your real estate taxes. It would be a big reduction in your monthly payment to not have your mortgage, but don’t forget to factor in paying your home insurance and property taxes directly in your post-mortgage budget.
Forever Home or a Stepping Stone?
Another important question to ask when evaluating if paying off your mortgage early should be a goal for you is, what are your long-term housing plans? Do you intend to stay in your current home forever? Do you hope to upgrade? Do you dream of building a custom home? If your goal is to stay in your current home forever, eliminating your mortgage payment as soon as possible could be a great plan. However, if you plan to move to a different home, and especially if you hope to build a custom home you may creating unnecessary challenges for yourself if you start throwing extra money at your mortgage.
If you plan to purchase a different home before your mortgage is paid off and sell your existing home, there could be some significant advantages to building up cash savings instead of paying extra money toward your mortgage. Having significant cash available allows you to have greater negotiating power and flexibility when searching for your next home that is not dependent on the sale of your existing home.
If you hope to build a custom home someday, this is even more significant. Generally, when you build a custom home you need to purchase the land and qualify for construction loans that require hefty down payments. If you have significant equity in your home, but no cash on hand this becomes much more challenging.
Factor in the Interest Rate
We have been in a long season of historically low interest rates. This means that your borrowed money is cheap. It is common to see interest rates on 30-year fixed mortgages around 4%, which is drastically different than when mortgage interest rates were over 18% in the early 1980s. Good financial advice is always situational. You should always ask yourself, “Am I using my money in the most productive and beneficial way possible.” If you have a low interest rate on your mortgage, you may end up much farther ahead putting additional money into your retirement account or an accessible investment account than putting extra toward your mortgage. Not only are you likely to earn a larger percentage in an investment account than your interest rates, that extra money will compound in your account year after year.
What is Financial Freedom?
Don’t settle for someone else’s dream. What does financial freedom mean to you? Paying down your mortgage could be a great step to accomplishing your goals, but I doubt your life mission is to own a home fee and clear. Don’t accept the easy answers and ask yourself the hard questions and keep asking them because over the course of our lives our answers can develop and change. What is most important in life? What are the things you truly want to accomplish? What does success mean to you? What do you value most? Once you answer these questions, we can determine how best to structure your finances to support your life mission. Remember, financial goals are never really the goal.