Why Never Paying Off Your Mortgage Can Be A Good Idea

By on March 21, 2014

Gone are the days where home owners are praised for paying off their home loans as soon as they have the means to do so. Nowadays we are so crazy to even suggest that maybe, just maybe, we should never pay off our mortgages so that we can join the elite group of “savvy” consumers. Being financially “savvy” is a sexy word to be associated with indeed. And given that we will possibly never see interest rates so low again in our lifetimes, the radical suggestion does seem to hold some water.

Firstly by this suggestion, it does not mean to change your phone number, get a new email address and wear big shades to avoid your lender’s collectors. It does not mean to stop making payments at all. The notion of never paying off your mortgage refers to a strategy of cashing out and refinancing frequently while stretching out the tenor each time. The cash these activities generate will then be used to pay off high interest loans or put in high return investments. It becomes a game of cash flow and arbitrage rather than wealth accumulation. So what are your considerations before going knee-deep into this plan?

Amount of equity is vital

It is too easy to assume that your house should follow the protocol of appreciation. But this is not always the case. Either that or you could find that the amount of appreciation is too small to observe under a microscope. To refinance with an additional term loan, you generally need to have a minimum 20% equity in order to avoid private mortgage insurance.

But other than that, the total loan amount is usually based on the value of a property. This means that if you qualify for 70% loan to value under current regulations, you will be able to borrow up to $350,000 for a $500,000 house. And if your current outstanding principle is $348,000, it really does not make sense to go ahead with it especially when you take into account the closing costs involved. But if we are talking about huge savings, maybe it can still be worthwhile. This is something you have to work out yourself with a trusty financial calculator.

dont want to pay off mortgageWhen will you recoup your costs?

There are a number of costs that you will incur when refinancing. The very first thing on top of the list to check is the prepayment penalty. This should be clearly stated in the original facility letter. If you are still within the period where this redemption penalty is active, consider talking to your bank. Maybe they will be willing to waive it if you are remortgaging with them. If not, you must factor this cost into your spread sheet and see if it is a better move to wait till you get pass this period. It can be tough to pinpoint a right time to refinance.

After which, you can begin to work down your list of closing costs. These costs are to be paid up front. But very often you can get a new lender to subsidize or waive it for you as they could more excited than you think on acquiring you as a new client. Just remember to ask. It does not hurt to do that and just takes a minute. The items you will see include a loan origination fee, related insurance, appraisal fee, points, physical inspection fee, title search, legal fees, and survey fees. You can sometimes get a lender to offer you an alternative deal where they absorb all these fees for you. But usually these gracious acts will be balanced up with a higher interest rate. So to ensure that you are not offered that from the start, you should ask to see the normal deals first. Then ask for these waivers without compromising on the rates which you can get.

As it is the norm to refinance to a lower interest rate unless you are one of those investment mavericks who willingly replace their existing loan with a more daunting one to get access to more cash, you will usually recoup your costs over time. Your monthly payments will be lower as you are on a lower rate with an extended tenor. It does not take a genius to figure out that you will be better off in terms of cash flow. But take note that you will now be paying more in overall interest charges. And you could also be subject to unfriendly interest rates due to adverse credit. If you had significantly increased your loan amount, you might be making a higher installment as you might have.

How to best use the funds generated?

Before you even call up your stock broker and ask about the latest raging bulls, you must understand that the cash from your home equity is not free. You are paying an interest on it. This means that there are 2 fundamental ways to make this work out for you. You either pay off debts that have a higher interest, or make investments with a higher return. But please if the difference is just a decimal percentage point, you should look or something that has more bite.

A common use of this cash is to consolidate all your debts by paying them off. When interest rates on credit cards and overdrafts are so high, you will be wise to pay them off. Almost every types of loan you can think of will have a higher interest compared to a mortgage. This is because a mortgage is secured to the most conventionally valuable asset there is. Because of how secure this asset is, lenders are willing to offer low rates. They are unlikely to lose money as unlike stocks which can crash to zero value overnight, it does not happen to real estate. On top of that, a mortgage debt is tax deductible. When you do consolidate your debts this way, be mindful that you are now replacing unsecured debt with one that is secured. Meaning your house is on the line now.

Investment is a really tricky thing. It is hard to measure what constitutes to being a really good investment. But if you do not have an aggressive appetite, you can target to just make a simple profit. When a treasury bond is giving a 4% yield and your mortgage rate is 1%, even your 3 year old son should be able to see that you will be making a 3% profit by simple arbitrage. At current low mortgage rates, you could even be getting a good return by putting your money into fixed deposits.

Tax benefits

As your mortgage is slowly paid down, pretty soon you will see for yourself that a bigger and bigger portion of your payments are going towards repaying the principle sum instead of interest. As you can only get a tax break from the interest you pay, your tax benefits will start to diminish as well. Refinancing actually restarts the clock where you go back to paying more interest than principle. You will be better off this way regarding tax matters.

It can really sound radical to even suggest never to pay off your mortgage. But when you put up all the numbers, it can start to make financial sense. Just remember not to take on the type of risks that will leave you with nightmares at night. And if you have no idea what to do with extra cash, you could be better of sticking with what you currently have.



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