Pay Off Your Mortgage or Not ?

   

This is probably the most popular question related to mortgage. If you have extra money, will you better off use it to pay off the mortgage (reduce your home loan) or not ? What you will read here need open mind and a little bit knowledge about economy but if you never though about it before, it probably will blow your mind !

Pay off Mortgage or Not ?

Emotional Factor: Itch To Have Debt

Yes, a home loan or mortgage is a debt. The decision to pay off your mortgage or not, in my opinion, should not be based on emotional decision. Yes, human is emotional being, but this decision is purely based on financial knowledge. If you have a (limiting) believe that “Debt is bad” (then you need to learn about debt and leverage) or “Not having debt is always better than no having debt” (huge mistake, check all super wealthy people in the world who doesn’t have debt… zero – they are all have massive debt) – then just stop here as no matter what I or other said that will not matter already. Trust me, debt is not always bad (yes, there are bad debts) and Debt is very important tools in getting financial goal.

So, let’s go back to the original question with open mind: should I pay off mortgage or not ?

Home loan and Its Interest Rate Do Not Grow

If you have $500,000 home loan for your property. While your property can grow in value (doesn’t matter how slow or fast) — maybe increase 10% in value within 5 years, i.e: 5 years from now it worth $550,000 — the debt will always be $500,000 and decreasing if you pay the principal and interest, or it will stay the same if you only pay the interest.. Let say in this case we don’t pay the principal of the debt , just the interest.

Then if you can take a fix interest of 5% for 30 years, every year for 30 years you will need to pay 5% x $500,000 = $25,000 per year.

If you take the variable/moving interest rate, then probably it changes from 3% – 10% over times, meaning you will pay maximum of 10% x $500,000 = $50,000 per year when the interest is 10%.

Salary / Income and Inflation

During 30 years of span, inflation will eat up the value of money. That’s why $1000 10 years ago is much more valuable compare to $1000 today. With the same analogy, say if a salary of fresh graduate engineer is now $60,000, 10 years ago, it will not be $60,000 much less as somehow it will greatly determine by inflation rate.

In other words, assuming the same position and responsibility in a stable job market, income (i.e: salary) will generally go up with the proportion of inflation. For example: as Engineer you earn $100k per year. Ten years from now, will you still earn $100k? The chance is you will earn much more than that, not only because inflation adjustment, but also with the promotion in corporate ladder (if you are in business, from the growth of your business as well).

Therefore say the Engineer above buy the above property. So, with $100,000 salary per year, he need to pay $25,000 per year. The proportion is 25%. Ten years from now, say the salary is now $150,000, then with still paying $25,000 per year of interest, the proportion of the mortgage is only 17% then.

Making inflation and time your friend

This is why Robert Kiyosaki, the Rich Dad, make a remark that “Savers are Losers” : if you have debt – especially the large one, time and inflation become your best friends. Over time, thanks to inflation and increasing income, the proportion of the debt become less and less. In other words, over time, the mortgage become easier and easier. In this case: yes, maybe our Engineer a little bit struggle with $100k salary and $25 mortgage, but if it’s become $200k salary and still $25k mortgage per year, I don’t think it’s big matter anymore. It gets easier over time.

And to top it off, at the end you can actually make the bank to finally pay off this mortgage with their money. Isn’t that great?

So, What Then ?

Of course, the best use for your extra money is for investing. Do not ever consider your extra money to be used only for consumption or lifestyle – unless it’s being budgeted before. For example: you just wont $10,000 from lottery. Rather than use the money to buy new LED TV or jewelry, then it’s better to pay off your mortgage. But even better if you use the money to buy some good blue chip stock that can give you return and growth.

The simplest form of “investing” is put the money in high interest saving account, but this “strategy” is not too effective as the return is pretty low.Investing is literally a race between inflation rate and Return of Investment – as long as the ROI is higher significantly than inflation you will be ahead. And this will give you double benefit. Not only the homeloan become easier to service overtime, the passive income from investing will make your wealth come faster.

But before do investing, make sure you read this: Postpone Investing! Do this First ! . After that, there are too many “strategy” to do some investing such share trading and property investing.

So? Happy Investing, then !

Related Posts

• Inflation Is NOT Price Goes Up: Common Misconception

Denis Kristanda  

Leave a comment