Is paying off a mortgage the best option?

June 26th, 2009, 3:00 am · 10 Comments · posted by Mathew Padilla

Randy Johnson, president of Independence Mortgage Co. in Newport Beach, author of “How to Save Thousands of Dollars on Your Home Mortgage” and a mortgage broker since 1983, answers questions…

Q. My home in Orange County has a value of about $800,000. My remaining mortgage is less than $100,000. I’m about half way through a 15-year loan with an interest rate of 5.38%. Monthly payments are $1,394 (not including taxes). Almost $1,000 of this is now going toward principal. Given these parameters, would I be ahead of the financial curve if I were to pay off the remaining loan? I have read articles both pro and con on this issue. If it makes any difference in the calculations, I run a business out of my home and deduct related home office expenses.

A. Paying off a loan is financially identical to making a guaranteed investment with a return of whatever the note rate is. There are not many safe 5.375% investments around these days.

If you took $100,000 out of an account where it is earning 1% or 2%, it reduces your annual income by $1,000 or $2,000. Using it to pay the loan off would save $5,375 in interest. This is very attractive so I would strongly consider it.

That said, I would do this only if you had enough resources to be comfortable doing so. You don’t want to lose all your liquidity. Having cash and a mortgage is better than having no cash and no mortgage, if you see what I mean.

Concerned in Fountain Valley asks:
Q. The mortgage on our home is in my husband’s name only. The house is in our trust as community property. We are both in our seventies and I would like to find out if I can continue paying off the same mortgage if my husband should die before me or would I have to refinance the loan? Also our children are named as beneficiaries. If we both passed away could they continue the same loan or would they have to refinance?

A. To the extent that this a legal question, you ought to ask a lawyer. I’ll give you my “industry experience based opinion” which is that neither his death nor yours would trigger the “due on sale clause” that would require it to be paid off. Our industry is greedy, but I don’t think we are mean. Sleep well and don’t worry.

That’s it. If you want Johnson to answer a question, email it to Mathew Padilla at mapadilla(at)ocregister.com. Include your name or nickname and the city you live in — that information will be published with your question.

Johnson will answer up to three questions each week, so keep checking back for a response. If many questions are submitted, it could take a while to get a response, or he may never get to it. Also, readers keep submitting variations on the same question, which has already been answered: what to do when you can no longer afford your mortgage. I have decided not to publish most of those questions, because they are repetitive, although I appreciate the difficult situation many homeowners are in these days.

Read prior questions and answers by clicking on the headlines below…

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Liar Loan says:

June 26, 2009 at 8:31 am

Question one is good advice, except the guaranteed rate of return should be calculated based on after tax interest. Depending on your tax bracket, you might only be getting a real guaranteed return of 3.5% or less, due to the mortgage interest deduction. For instance, if you’re in the 25% federal bracket and the 10.3% state bracket (newly enacted by the governator) then the following formula would calculate your true mortgage rate (1 - .25 - .103) * 5.375% = 3.478%. If your federal bracket is higher than 25% substitute that bracket for the .25 portion of the equation and your savings are even greater. (The higher brackets are 28%, 33%, and 35%).

With the lower 3.5% (or less) guaranteed return for paying off the mortgage, it might still make sense to pay if off compared to supersafe CD investments or T-Bonds. But if your investment plan includes anything more aggressive than that such as corporate bonds, municipal bonds, or stocks, than the money might be better allocated towards those asset classes, because in effect you have a really cheap loan (Almost free when compared to inflation).

In regards to question #2, all I can say is speak for yourself Randy. Not everybody is as greedy as you.

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olsrfbum says:

June 26, 2009 at 10:31 am

Flat out, pay off your house as fast as you can, period.

Barry says:

June 26, 2009 at 11:32 am

For comparison purposes, does it matter if it’s done before or after taxes? Say the yield on the mortgage repayment is reduced by the tax savings lost, wouldn’t you have to compare that to the yield on any other taxable investment after taxes?

Liar Loan says:

June 26, 2009 at 12:47 pm

That’s a good point, but bonds and stocks are more tax advantaged. So paying off your mortgage costs you more in tax savings than being taxed on capital gains or dividends which are taxed at 15% through 2010, and rise to 20% for capital gains after that. (Dividends will revert to your normal tax bracket after 2010.) Also, municipal bonds can be tax free.

So with the patchwork of tax ramifications involved, I still think comparing the after tax benefits is the smart thing to do.

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Wisdom Speaker says:

June 26, 2009 at 4:21 pm

In the current economy with both jobs and home values at risk, pre-paying the mortgage also may not make sense if you’re close to being underwater on the loan. For those who have a California purchase-money mortgage (which is a non-recourse loan, IIRC), if you default on the loan you may lose the house (after a long delay), but you won’t lose any other assets. If you put your cash into prepaying a mortgage which is larger than what the house might sell for, and then you lose your job and your house, you’ve lost everything since you have no cash. On the other hand, if you hang onto your cash and then lose the home, you’ve got something to sustain you until you get back on track.

sharpster says:

July 11, 2009 at 9:20 am

All I know it, if your moniker is “Wisdom Speaker”, you better be damn sure your post doesn’t suck.

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Bill says:

June 26, 2009 at 5:11 pm

Matt,

Let me help you out on this slow news day!

Regulators shut 4 banks; 44 failures this year.

MetroPacific Bank in Irvine, Calif. got bit today.

http://finance.yahoo.com/news/Regulators-shut-4-banks-44-apf-28092677.html?x=0&sec=topStories&pos=1&asset=&ccode=

Mathew Padilla says:

June 26, 2009 at 6:28 pm

Thanks Bill, I saw this in my inbox, I am on FDIC blast list, and just blogged it.

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republicans are TRAITORS says:

June 26, 2009 at 10:28 pm

Obama’s banksters don’t want you to pay off anything. Comrade Barnanke and Comrade Geithner order you in your best interest to borrow, borrow, borrow. In fact, they just printed several trillion dollars and gave it to their bankster friends so their friends can lend it to you.

Don’t do what the criminals want you to do. Don’t get into debt slavery.

June 27, 2009 at 7:19 am

Stay in debt and you will never be able to get off the tread mill. What is the point in buying a house you cannot afford, its not going up in value, those days are over. Live,work and play where you can afford to live. There is much more to life than a huge monthly mortgage payment for the rest of your life. Learn to enjoy friends,Family and nature and you will find true happiness. Living within your means will take you there.

Orange County Register