Monday, April 11, 2011

Should You Pay Off Your Mortgage?

In my last post, I note that there's some really bad advice out there about a difficult decision: Do you or do you not pay off your mortgage.  "Ordinary Bob" asked for more help.  I'll try.

Disclaimers: This is a complicated question.  I do not give financial advice, I am not qualified to give financial advice.  I don't know you or your circumstances.  I'm going to highlight my personal concerns, which could be very different from yours.

Before I begin, an apology: I referred to Kelly Campbell as a woman.  Kelly Campbell is male.

Campbell states the obvious, and he says nothing particularly unique about a mortgage: If you can borrow money at a rate below the rate at which you think assets will appreciate, you can expect to make more money by borrowing to invest than if you didn't borrow.  Note the word expect.  This strategy involves leverage and more risk around uncertain outcomes.

He assumes that your house and investment portfolio increase in value by 5% and 8%, respectively.  I'll go out on a limb and assume he told his clients more or less the same thing in 2006.  Unclear if those people remain his clients.

In other words, he forgot to mention that investment returns are not guaranteed.  (Interesting that a Certified Financial Planner who touts his clean FINRA record on his website can make statements in a U.S. News column he cannot legally make in a client conversation.  If you're curious about that one, ask him to mail you a re-print of the article.  I'll bet $1 the re-print he sends has multiple disclaimers!)

Buying a house with a mortgage is just a leveraged investment. Yes, you live in it, enjoy it, yada yada yada.  But, you can borrow cheaply against stocks and mutual funds too.  It's called a margin loan, and that interest is also tax deductible.

So, you have to ask yourself if you can stomach the risk of more leveraged investing.  Most people cannot.  You probably could not cope with the volatility of your house price if you watched it.  (Check Zillow's monthly marks on your house.  I'll be you another $1 you rationalize that Zillow is just wrong, that they don't know your house.)  

For me, liquidity is the next issue to consider when thinking about paying off a mortgage.  Liquidity provides financial flexibility.  A pile of cash that could pay off your mortgage provides liquidity.  Pay off your mortgage, your liquidity disappears with your loan.  Suppose after you pay off your mortgage, you lose your job, so you can't get a new loan and your short cash.  Or, you want to move to a great new job, and you can't sell the old house.  You have no cash to buy another.  Heck, what if the stock market really crashes, and all of a sudden Campbell's risky 8% becomes a not so risky 20% and you have no cash to invest??

Lastly, I think about inflation.  Everyone's talking about inflation these days.  Did you buy gold for the end of the world yet?!?  Seems pricey, right?  Many logical inflation hedges seem uncomfortably priced.  I hold a relatively large amount of TIPS.  But even they aren't perfect.  If you own a house, you're already "long" a real asset, albeit in a completely undiversified and illiquid way.  With a 30 year mortgage, however, you're short a long duration bond.  That's very convenient if you think interest rates are going to rise dramatically due to inflation.  That's right, you pay off the mortgage with depreciated dollars after inflation strikes. 

So you ask, have I paid off my mortgage?  Not yet.  But, my circumstances are very different from yours!