You’re a Fool to Prepay Your Mortgage

Daniel Penzing
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Here are the reasons you should get a 30-year fixed mortgage:

You want to buy a property and not move for at least 30 years.

You have a positive monthly cash flow, which is to say you get back more from your investment than you pay out. For example, if you are living in the property, you could claim the rental income as tax deduction and therefore, pay less tax.

You would like to build cash in the bank and not borrow additional money in the future.

If any of the above applies to you, you can consider getting a 30-year fixed mortgage for a home. Here are some things you need to know before you sign onto a 30-year fixed mortgage:

You will not be able to get a loan anymore after you turn 80 years old! After this, you have to pay off the mortgage with your own money if you do not want to foreclose. Because of this, make sure that you have enough funds to pay off the mortgage before you retire, so that you can avoid foreclosure.

You will need to make monthly payments until you are 70 years old. In fact, the biggest mistake beginner home owners make is to get a 30-year mortgage when they should have gotten a 15-year mortgage.

Therefore, if you have the intention to sell the property before you turn 80, make sure that you get a 15-year mortgage! You will be able to sell it for a higher price and move to a bigger home.

A Home Is an Illiquid Asset

When you pay off your mortgage before the scheduled date, you are locking in a very low rate of return, often just a nominal amount. If you are fortunate enmough to have a lump sum come your way, you might want to consider using it in some other way in order to secure a higher return.

The reason you locked in this low rate of return is that you have reduced your risk. You don’t have to worry about losing your entire investment. If prices fall, you’ll make the agreed upon payment. In effect, you’ve taken out an insurance policy on your home value.

If you prepaid your mortgage, someone else will have to shoulder the risk if home prices fall, which almost always leads to a decline in market value. The simple fact is that you sacrificed one source of income so you could enjoy the fruits of another.

There are times when it may make sense to pay off your mortgage early, but doing so is an act of pure speculation that you can never be sure about. If you meet the requirements for prepayment, it is a good idea to talk to your lender about whether it makes sense. You might also want to consider the quality of servicing you have received.

Your Primary Residence Is not an Investment

People are reluctant to invest in real estate when they first start out mainly because they perceive it to be risky. However, over the long term, real estate is one of the safest investments you can make. You have time on your side. It gives you the flexibility to get creative with the income stream by either choosing not to sell your home and rent it out, or to obtain a mortgage and do the same when you are in a position to do so.

Mortgage interest rates are at historic lows, so if you have the financial capacity to do so, consider prepaying your mortgage. It is an excellent opportunity to build wealth that you and your family can enjoy for years to come.

You won’t control the real estate market but you can control prepaying your mortgage. Put a date on your calendar every month because you won’t want to have to live through another housing crisis. If you can, make a mortgage prepayment every month. It will automatically put extra cash in your pocket.

If you are not able to do that, then do it once a year. As long as you have the cash, do it. Your investment is your home. You never know when you may need to pull out that cash for emergencies or to help your children fund their education.

Prepaying mortgage can be one of the best financial decisions you will ever make.

Best to Invest Instead of a Shorter-Term Mortgage

In many cases, you’re better off investing the difference between your current mortgage and the new, shorter-term mortgage rather than prepaying your mortgage.

This is because interest rates are lower now than they where when you bought your house, making the spread that you would earn from the money you invested well worth the cost.

If you’ve bought a house recently, prepaying your mortgage won’t help. It’s best to embrace the power of the compounding interest you’ll earn by letting your investment grow. It’ll help you pay off your mortgage sooner rather than spend your funds elsewhere.

A Mortgage Is Tax Deductible

One key fact to remember is that you are not pre-paying any mortgage when you prepay your mortgage.

In fact, you are not pre-paying anything. You’re making a cash payment for an amount not yet due. If you received that amount of money in pay check form, it would not be deductible.

Prepaying your mortgage is simply a way to redirect your own funds to yourself (instead of to your mortgage).

But you do it by increasing the amount you pay on your mortgage payment. This will save you interest and shorten the life of the loan.

There is nothing in this scenario that implies what you are doing is tax deductible.

You Will Always Have House Payments

When you’re getting ready to pay your mortgage for the first time, you might find the idea of paying an enormous lump sum quite appealing. After all, there’s a certain convenience in mowing one large check each month rather than splitting it up into a bunch of smaller checks.

However, it’s important to consider the many ways in which paying your mortgage in one lump sum can actually end up costing you more money throughout your mortgage term. Here are a few important reasons why you should avoid prepaying your mortgage:

Mortgage Interest Rates Changes Over Time

If you’re paying more than the interest on your loan in one lump sum, you’re essentially giving your lender a huge loan to cover interest charges on the loan for a certain period of time. Whenever interest rate dip, it will be more cost effective to just pay off the loan early. But interest rates will also rise at some point, so you won’t be able to capitalize on those rising rates unless you hold onto the loan long enough for rates to go up. If you prepay your mortgage, you’ll lose out on that valuable option.

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