Operation Mortgage Freedom or Prisoner of Myth? The Soldier Dollar Wars

Allied World War I soldiers

Image by Dunechaser via Flickr

We all want the truth when it comes to financing our home, right?  What is truth?  This is part three of a series on housing and mortgages.  The last two posts covered some common beliefs about home ownership:

  1. September 8, 2010: We looked at the history of “The American Dream” and the groups that profit from home ownership
  2. September 12, 2010: I debunked the idea that your primary residence is an investment in real estate.  We clearly demonstrated that it is consumption of shelter

Over the next several posts we’ll look at some common beliefs about mortgages.

Common Mortgage Belief #1: I’ll be more financially secure the sooner I pay off my mortgage.

Uncommon Sense:  Most people have a limited supply of fresh dollars coming from wages, savings, investments and other sources.  Retirees have even more limited income.  Think of your cash as soldiers in your financial army.  Each soldier-dollar deployed to repay your mortgage is not available to fight other battles including investments that pay a positive real return and reducing higher interest debt.

We clearly showed in an earlier post that your primary residence is not an investment and it’s a losing strategy to borrow money to make a real estate “investment” play on your home.  Since every soldier-dollar spent on your primary residence will lose money it is the last place to put extra cash.

If you invested all of your free cash into reducing your mortgage, eventually you’d own your house free and clear.  However, with no money in investment and bank accounts that recruit new dollars, you’d have to borrow money in retirement from a home equity loan or reverse mortgage to pay for basic living expenses.

You can’t eat a roof tile and there’s not a liquid market to sell parts and pieces of your home.  You can only sell the whole and then you’d be making mortgage payments or rent payments on a home again.  What have you gained?

There is a strong argument that paying off a home mortgage has a positive psychological impact on the borrower.  However, that argument can’t be effectively cloaked in the disguise of investment returns.  The feelings of the borrower have no place in sound financial decision making.

Have you sent your soldier-dollars into the mortgage reduction battle?  What objective do you hope to achieve?


About Michael Shelton

Your Business Coach Facilitating Delegation and Work Group Engagement Michael Shelton has over twenty-five years of business and military accomplishments, including extensive experience with one of the largest, publicly traded real estate investment trusts (REIT). He is a qualified business coach with assignments in cross-functional work group management, strategic planning, unit leadership, joint venture acquisitions, executive education, mentoring, training and merger integration. Michael has accumulated best practices for building committed work groups from more than $4 billion of capital markets transactions and commercial property development. He served as a commissioned officer and helicopter pilot in the U.S. Army, and earned his MBA from The University of Arizona. Michael has served as a major conference panelist and is the author of Cash Flow Rich, Winning Ways to Evaluate and Finance Real Estate. Today, he helps business owners get more work group engagement as President and CEO of Shelton Business Services, LLC in Scottsdale, Arizona. Disclaimer: I don't offer investment, legal or tax advice. Talk to your broker, accountant or lawyer for investment, tax and legal help. I might own stock in the companies I mention on-line. My posts, tweets and other on-line activity are my personal thoughts and don't represent my employer or company.
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8 Responses to Operation Mortgage Freedom or Prisoner of Myth? The Soldier Dollar Wars

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  3. Matt says:

    Locked in on your return means security and stability. Saving 6% on my mortgage tax free is very close to 8% gains in the stock market when you include the taxes you pay when you decide to sell them, not to mention the fee’s usually involved when buying and selling stocks. You could also include the appreciation on your homes value when you sell as a gain but that may be a separate issue.

    Historically the stock market has gained an average of 8 – 12% but history is no guarantee. If I would have invested in the S&P 500 in Jan 2000 I would have lost a lot of money if I sold today and would have been better off putting the money under my mattress than the stock market. I’d rather invest in paying off my home and give up the potential to loose everything in the stock market. But for some people they like the risk involved that could generate large returns. I prefer to take these risks after I pay off my home or use my 401k for more risky investments that my employer matches so that if I loose money then my employers match helps cushion the loss.

    • Matt, you are correct, past performance is no guaranty of future performance. HIndsight is always 20/20. Let me ask you this question though. If your house is a great investment, why are you prepaying the mortgage? If the annual positive cash flow (i.e. earnings or other income; unless you have a rent paying tenant there typically is no income) from your home plus any capital gain realized during the year (only if you sell it) is greater than your 6% cost of capital (your mortgage interest rate) then you are generating positive leveraged returns. In that case you’d want to keep as much 6% debt in place to continue to reap those leveraged returns and take your extra principal payment and put it to work somewhere else. What do you think?

      • Matt says:

        I prepay my mortgage to save the 6% in interest that I am paying on the loan. I purchase my home to reap the reward of increased property value.
        The increase in property value leverages me against inflation whether I pay off the mortgage or not. In other words, even if I can not payoff my mortgage there is still a good reason to purchase a home vs renting.
        Here’s a scenario. You purchase a home for $100,000. You made a good investment and 10 years from now your home is worth $135,000. Your payment was $900 a month at 6% interest when you first purchased your home and you have not paid any extra and continue to pay $900 a month. For argument sake, let’s say you have $80,000 left to pay on the mortgage. In ten years time you now have a $135,000 home paying a monthly price for a $100,000 home. What a bargain. If anyone else purchases this home at this point in time they would be paying a monthly fee for a $135,000 home.
        Now, at this time you could payoff the $80,000 completely and be saving 6% interest tax free for the remaining term of the loan. Refer to an amortization table to see how much money in interest you saved, tax free and guaranteed. You could, if you are really interested in investing, take this 6% interest that you are saving every month and place it into another type of investment. Then you would be gaining the 6% tax free money that you saved in interest for paying off your mortgage early and the gains from the other investment that you have invested in.
        So, the real investment is in the property value of your home but saving money (which is better than making money since it’s tax free) on the interest that you would be paying on the mortgage is also a value.
        Of course, if you find another investment that requires a lump sum that will pay off better than the savings on your home mortgage interest tax free then invest in that. You would still benefit in the increase in the property value of your home. However, I have not found an investment like this that is guaranteed.

        I enjoy this arguement. I wish someone smarter than me could do the math and really show which one is the best investment. Calculations that I have seen always leave out things such as brokerage fees, taxes on the amount once you sell the stocks/bonds, the increase of the value of your home in the investment period, and using a real scenario for the stock market in a 15/30 yr term.

  4. Matt says:

    You are making assumptions here. Everyone’s situation is different. I agree that if you are banking on paying off your mortgage as your only investment and you have no savings then you are in trouble. I think anyone in their right mind would pay off any higher interest rate debt first and have some savings before considering paying off their mortgage early. There is the arguement that you could make more money investing in the stock market or something else. If this is true, someone tell me an investment that is 100% secure and the return rate is a better than my mortgage loan APR, tax free (like the interest I am saving when paying off my mortgage), and also has a rate of return that matches the property value appreciation like my home.

    For example, Today my fixed mortgage rate is 6% APR. My Money market variable rate of return in .65% APR (yes, less than 1 %) and I pay taxes as income on the return. If I had $150,000 in my money market account, it seems to me that I would be better off paying off my $100,000 mortgage with my money market funds and get a tax free (no taxes on saving money paying interest) 6% return than the .65% return plus paying taxes.

    Also, even if I was to just pay a little extra on my mortgage each month it would be a better invesment than my money market account. But, again it depends of your situation; it would not be worth paying extra each month if I plan to sell the house next year or I am in fear of loosing my job and loosing my house. If there is any chance that you will loose your home to the bank before you sell it or pay it off, never pay extra on the mortgage.

    • Matt, I agree that everyone’s situation is different and you have to sit down and do the math. One thing to remember is that once you prepay your mortgage you are locking in your “return” on those dollars. So if I prepay some of my 15 year mortgage in year one, I’m locking in that interest savings on those dollars for 14 more years. HIstorically, stocks return an 8-12% average return over the long term. You’d be giving up the potential to earn a higher return on a future opportunity. A dollar repaid is gone forever.

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