The Pros and Cons of Paying Off Your Mortgage Early
Given current economic pressures, many people are trying to erase debt from their financial picture and focus on saving and safer investments. Americans are paying down their credit cards and cautiously borrowing money. Not surprisingly, paying down the home mortgage has become an attractive option for people in a financial position to do so.
However, paying off your mortgage isn’t necessarily something you always want to do. It turns out there are various considerations you should weigh to decide whether paying off your mortgage is the right move. Let’s take a look at some of the factors that could influence your decision:
Do you have other debt?
If you are still paying off a car or carrying credit card debt, then paying off your mortgage shouldn’t necessarily be your first concern. It all comes down to interest rates. Chances are your mortgage carries the lowest interest rate you have. Why prioritize paying off a loan at a much lower interest rate when you should be prioritizing paying off more expensive loans, such as credit cards?
Peace of mind.
For many, paying off the mortgage brings a psychological benefit. It’s true for many people that they are not happy when they owe money; it represents an insecure state of personal finances for them. That’s completely understandable, but curbing an emotional response to consider how you can best make your money work for you is probably the best way to go. For some, that could indeed be to pay off the mortgage. For others, it might make more sense to stick to the original term of the loan. The best rational outcome should ultimately prove the most psychologically satisfying.
Taxes.
If you pay off your loan early, you will lose the ability to write off the mortgage interest you have paid during the tax year. That can amount to a considerable deduction. However, don’t be oversold on this issue. If you don’t itemize your deductions, or are confident that you won’t be itemizing by the time you pay off your loan early, then this might not apply.*
Make sure to do the math.
As mentioned, your money should be working for you, so you need to take a moment and determine the most beneficial way to use your capital. Paying down your mortgage is one way, but can you get that money to perform better for you through investing? Whichever is the higher rate will be the strategy you want to pursue. Then again, you also need to factor in the taxes that will come into play if your investments pay off. How will capital gains taxes fit into the equation?
Remember that your home is an investment.
The equity you place in your home will most likely pay you back quite well. While the real estate market has dips, it has been on an upward trend in the broader sense. Moreover, if you pay off your home, you’ve now eliminated a major expense from your retirement budget, which means you’ll need less money to retire. That said, you are sacrificing diversification and the ability to rapidly respond to new opportunities.
Inflation can work for you, believe it or not.
Working on the assumption that there will be inflation in the coming years, what you pay now as a mortgage payment will be relatively less in 10, 20 or 30 years. So if you pay off early, you lose the opportunity to have inflation actually work to your benefit for a change.
Putting yourself in a less secure situation with a lender.
It sounds counter-intuitive, but paying off a mortgage can actually hamper your flexibility to make your money work for you, because your money has gone to your lender, as opposed to an investment where it can work for you and from which you can draw income. In today’s employment landscape, that’s an important consideration.
As you can see, deciding whether or not to pay off your loan early is not a cut-and-dried decision by any stretch. It requires a long, careful look at the numbers and potential life scenarios to determine the smart play. For some it will be to pay off the loan early, and for others paying the loan off in its original term is the way to go.
If you’re considering paying off your loan early, I’d love to review all the considerations with you so that you can make the right decision for you. Simply contact me using the information on this message, and I’ll be happy to help you carefully consider the pros and cons.
* WJB is not a tax advisory firm. The information contained in this article is for informational purposes only and may not reflect current tax year rules and regulations. Consult your tax advisor or the IRS for current tax year rules, restrictions and regulations.
© 2011 W.J. Bradley Mortgage Capital Corp., 201 Columbine Street Suite 300, Denver, CO 80206. Phone #303-825-5670. NMLS ID 3233. Trade/service marks are the property of W.J. Bradley Mortgage Capital Corp. This is not a commitment to lend. Restrictions apply. All rights reserved. Some products may not be available in all states. WJB is not acting on behalf of or at the direction of HUD/FHA or the federal government.
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Adjustable Rate Mortgages Adjusting To 3.000 Percent Right Now
If your ARM is due to adjust this spring, your best move may be to allow it. Don’t rush to refinance — your rate may be adjusting lower.
It’s because of how adjusted mortgage rates are calculated.
First, let’s look at the lifecycle of a conventional, adjustable rate mortgage:
- There’s a “starter period” of several years in which the interest rate remains fixed.
- There’s an initial adjustment to rate after the starter period. This is called the “first adjustment”.
- There’s a subsequent adjustment until the loan’s term expires. The adjustment is usually annual.
The starter period will vary from 1 to 10 years, but once that timeframe ends, and the first adjustment occurs, conventional ARMs enter a lifecycle phase that is common among all ARMs — regular rate adjustments based on some pre-set formula until the loan is paid in full, and retired.
For conventional ARMs adjusting in 2011, that formula is most commonly defined as:
(12-Month LIBOR) + (2.250 Percent) = (Adjusted Mortgage Rate)
LIBOR is an acronym for London Interbank Offered Rate. It’s the rate at which banks borrow money from each other. It’s also the variable portion of the adjustable mortgage rate equation. The corresponding constant is typically 2.25%.
Since March 2010, LIBOR has been low and, as a result, adjusting mortgage rates have been low, too.
In 2009, 5-year ARMs adjusted to 6 percent or higher. Today, they’re adjusting near 3.000 percent.
That’s a big shift.
Therefore, strictly based on mathematics, letting your ARM adjust this year could be smarter than refinancing it. You may get yourself a lower rate.
Either way, talk to your loan officer. With mortgage rates still near historical lows, homeowners have interesting options. Just don’t wait too long. LIBOR — and mortgage rates in general — are known to change quickly.
Comparing Mortgage Rates For Adjustable- And Fixed-Rate Mortgages
For some homeowners, electing to take an adjustable rate mortgage over a fixed rate one can be matter of budgeting. ARMs tend to carry lower mortgage rates and, therefore, lower monthly mortgage payment as compared to a comparable fixed rate loan.
Relative to fixed rate mortgages, current ARM pricing is excellent. Freddie Mac’s weekly Primary Mortgage Market Survey puts the 5-year ARM mortgage rate lower than the 30-year fixed rate mortgage rate by 1.02 percent.
On a $250,000 home loan, a 1.02 differential yields a payment savings of $149 per month.
ARMs are not for everyone, of course. Over time their rates can change and that can frighten people. An ARM can finish its respective 30-year lifespan with a mortgage rate as much as 6 percentage points higher from where it started. Some homeowners won’t like this.
Other homeowners, however, won’t mind it. For this group, the ARM can be a terrific fit. Especially with the huge, relative discount in today’s pricing.
A few scenarios that should warrant consideration of a 5-year ARM include homeowners that are:
- Buying a new home with the intent to sell within 5 years
- Currently financed with a 30-year fixed mortgage with plans to sell within 5 years
- Interested in low payments; comfortable with longer-term rate and payment uncertainty
In addition, homeowners with existing ARMs due for adjustment may want to refinance into a new ARM, if only to push the first adjustment date farther into the future.
Before choosing to go with an ARM, speak with your loan officer about how adjustable rate mortgages work, and their near- and long-term risks. Payment savings may be tempting, but with an ARM, payments are permanent.
Your ARM Is Adjusting Lower. Is There A Downside To Letting It?
When adjustable-rate mortgages are on the verge of adjusting, a common concern among homeowners is that their mortgage rates will adjust higher.
Well, this year, because of the math of how ARMs adjust, homeowners around the country are seeing that mortgage rates on ARMs can sometimes adjust lower, too.
Adjusting conforming mortgages are adjusting to as low as 3 percent.
As a quick review, here’s the timeline for most conforming adjustable-rate mortgages:
- There’s a “starter period” in which the interest rate remains fixed. This can range from 1-10 years.
- There’s a rate change after the starter period. It’s called the “first adjustment”.
- Subsequent, annual adjustments follow until the loan “ends”. This is usually after Year 30.
The adjustments each year are based on a math formula that’s included in the contract with your lender. It’s surprisingly basic. Each year, your new, adjusted mortgage rate is equal to the sum of some constant — usually 2.25 percent — and some variable. The variable is most commonly equal to the 12-month LIBOR.
As a formula, the math looks like this:
(Adjusted Mortgage Rates) = (12-Month LIBOR) + (2.250 Percent)
LIBOR is an acronym standing for London Interbank Offered Rate. It’s an interest rate at which banks borrow money from each other — very similar to our Fed Funds Rate here in the United States. And also like our Fed Funds Rate, LIBOR has been low lately.
As a result, adjusting mortgage rates have been low, too.
In 2009, 5-year ARMs adjusted to 6 percent or higher. Today, ARMs are adjusting to 3.000%.
Based on the math, you may want to let your ARM adjust with the market year. Or, if you plan to keep your home long-term and have concerns about adjustments in 2011 and beyond, it may be a good time to open a new ARM. The same forces that are driving down LIBOR and helping to keep mortgage rates low overall, too.
Consider talking to your loan officer and making a plan. With mortgage rates as low as they’ve been in history, most homeowners have options. Just don’t wait too long. LIBOR — and mortgage rates in general — are known to change quickly.
Should You Refinance Your ARM, Or Let It Adjust Lower?
If your adjustable rate mortgage is due to adjust this year, don’t go rushing to replace it just yet. Your soon-to-adjust mortgage rate may actually go lower. It’s related to the math behind the ARM.
Conventional, adjustable-rate mortgages share a common life cycle:
- There’s a “starter period” in which the interest rate remains fixed
- There’s an initial adjustment period after the starter period called the “first adjustment”
- There’s a subsequent annual adjustment until the loan’s term expires — usually at Year 30.
The starter period will vary from 1 to 10 years, but at the point of first adjustment, conventional ARMs become the same. A homeowner’s new, adjusted mortgage rate is determined by the sum of some constant, and a variable. The constant is most often 2.25% and the variable is most often the 12-month LIBOR.
As a formula, the math looks like this:
(Adjusted Mortgage Rates) = (12-Month LIBOR) + (2.250 Percent)
LIBOR is an acronym standing for London Interbank Offered Rate. It’s the rate at which banks borrow money from each other and, lately, LIBOR has been low. As a result, adjusting mortgage rates have been low, too.
Last year, 5-year ARMs were adjusting to 6 percent or higher. Today, they’re adjusting to 3.375%.
Based on the math, it may be wise to just let your ARM adjust this year. Or, depending on how long you plan to stay in your home, consider a refinance to a new ARM. Starter rates on today’s adjustable rate mortgages are exceptionally low , as are the rates for fixed rate loans.
Either way, talk to your loan officer about making a plan. With mortgage rates as low as they’ve ever been in history, homeowners have some interesting options. Just don’t wait too long. LIBOR — and mortgage rates in general — are known to change quickly.
Don’t Rush To Refinance That ARM — It May Be Adjusting To 3 Percent Or Lower
If your mortgage is set to adjust this year, the smart move may be to let it. Today’s conforming mortgages are adjusting lower than ever before — as low as 3 percent. It may not be what you expected when you signed for your ARM several years ago.
The reason why ARMs are adjusting lower is because of how they’re made.
When conforming adjustable-rate mortgages adjust, they adjust according to a pre-determined formula. The formula is the sum of a constant and a variable. The constant is usually 2.25 percent and the variable is a daily-changing interest rate called LIBOR.
The formula looks like this:
New Mortgage Rate = LIBOR + 2.250 percent
LIBOR is an acronym for London Interbank Offered Rate. It’s an interest rate at which banks borrow money from each other. In Fall 2008, when Lehman Brothers fell and sparked a global banking fear, LIBOR spiked as the risk of inter-bank borrowing jumped.
Since then, however, LIBOR is down.
Normalcy is returning to banking and the timing couldn’t be better for homeowners with ARMs. 15 months ago, a homeowner’s ARM may have adjusted to 6 1/2 percent. Today, that same ARM falls to just above 3.
As a strategy play, it might make sense to let your ARM adjust. Or, because fixed rates are still near 5 percent, converting that ARM to a long-term fixed-rate product might make sense, too. The decision is a balance between how low do you want your payment, and how long might you live in your home.
The longer you stay, the more it might make sense to switch to fixed-rate, even though ARM rates are so low.
If you’ve got an adjusting ARM, talk to your loan officer about your choices. Once March ends and the Fed withdraws its mortgage market support, mortgage rates may rise and the fixed-rate option may be gone.
