This whole “debt-free” concept sounds so… liberating. Kill the enslavers! Credit cards, car loans, student loans — gone! Easy enough. But, what about our mortgage? It seems like getting rid of our mortgage would take every available dollar we have as far as the eye can see, with nothing left over for college or retirement savings.
So, let’s consider the mortgage. It’s a different animal than our other personal debt. And not just because it’s so huge. Unlike consumer debt, our mortgage allows us to purchase real estate — an asset, something of lasting and potentially appreciating value. Even if we never get around to investing in anything else, our mortgage forces us to make regular investments in an asset.
This is very different from incurring debt just to get consumer goodies we can’t pay for — like a dinner out, fancy technology, or even a new car (which can plummet in value faster than we can pay down our loan!). At the end of the day, all we’ve got is debt and depreciating goodies. With our mortgage, we’ve got debt, but we also have a place to live and an asset.
The federal government treats mortgages differently than other debt. Our property taxes are deductible and so is our mortgage interest. And, we get a big tax break on profits from the sale of our home. As long as we own our home for two years, we’re not taxed at all on profits up to $500,000 for married couples and $250,000 for individuals.
A mortgage has downsides, of course. Real estate is the least liquid asset we can have. It cannot readily be turned into cash. And, as with any large loan, we pay a lot of interest. How much interest depends on our rate and how long we hold the note. Over the life of a $200,000, 30-year mortgage, at a rate of six percent, we pay $232,000 in interest and repay a total of $432,000. At seven percent, we pay $280,000 in interest and a total of $480,000.
We don’t have much control over our rate. But, we can change this picture drastically with a simple act — making one extra payment toward principal every year. Our $200,000, 30-year mortgage at seven percent has a monthly payment of $1330. One extra annual payment — about $110 a month — cuts six years off our note and saves $67,000 in interest. Bang!
Additional extra payments also help significantly, but our bang for the buck decreases. A second extra annual payment knocks off another four years and saves $38,000. A third knocks off over two years more and saves $25,000.
Out here in the universe of limited resources, though, we’ve got to balance mortgage payoff with competing goals of retirement and college. If we’re earning eight percent in our tax-deferred 401(k), perhaps that second or third additional mortgage payment would be better off there. But, market earnings are unpredictable, so the certain impact of that first additional mortgage payment sure seems worth it.
However we strike the balance among our financial goals, the key to our success is focusing every available dollar we have toward achieving them. Our dollars become truly valuable when we put them to work for us — and not the other way around. Now, isn’t that the real philosophy of debt-free?
What’s up next? Conquering the Paper Pile
Berry is not a Certified Financial Planner. She is a cum laude graduate of Texas Tech Law School and the self-taught manager of her own family’s finances. Before making financial decisions, consider pertinent information carefully and consider consulting a financial professional.