Should you be paying down mortgage debt when you refinance? Many people measure things as a return on investment, or a percentage return. If someone said they had an investment to tell you about that would provide you a .5% return you would not even listen. If someone said they had an investment to tell you about that would provide you a 4% return risk free, you would stop and hear them. A 4% return is an 8 fold return over a .5% return! And we all know that it seems hard to even impossible to get a decent return these days without taking on what many of us think is high risk. Investing in stocks these days still feels like a high risk proposition. We all get miserable returns from banks for CD’s and savings accounts.
What about investing in our house?
What’s that you say? You already bought a house, and improved it, so you already have invested in a house. So why not get a better return by investing in the house even more? Even if you have a 3.50% to 4% mortgage why not refinance? Certainly refinance if you are one of the few to still have a 4.5% to 6% mortgage! Pay some principal down and get a better return on your money than you currently are?
What is cashing in?
A few years ago I wrote an article about “cashing in” on your mortgage and paying the loan down. This is as opposed to “cashing out” and taking equity out and increasing your mortgage. You can read that blog here.
Measuring the rate of return
But I never bothered to measure the returns when paying your loan down. Obviously, the higher your interest rate the better “return” you get by paying down your mortgage. But even at today’s low mortgage rates taking available cash and paying down a hunk of your mortgage at 3.5% will get you a better return than having that money sit in a CD at .5% or a savings account at 0.15%!
Stocks versus paying your mortgage down
A financial advisor will argue that the stock market will, and in fact has, come back. And that over the long haul you will likely get 4% to 5% returns in the stock market. You will, when you are not busy losing a quarter or a half of your principal. Yes, you may get solid returns over the long haul, but with market gyrations at what cost to your principal?
But I am not writing to debate the pros and cons of investing in stocks. I am here to discuss the logic of taking a hunk of cash currently earning a low return and paying off debt that is at a much higher rate. For right now, and I think for the foreseeable future, that is a good use of capital. The debt payoff will provide a better and safer return. It also saves significant amounts of cash over the long haul by prepaying the mortgage and retiring debt earlier. So this pushes the returns even higher than the stated note rate of the mortgage you are paying off.
If you pay $50,000 of your mortgage down at 3.5% and take the cash for the pay down out of a .5% CD account, you just increased your return significantly. But, that $50,000 would cost $30,000 in interest over a 30 year mortgage term! And it would cost almost $20,000 on a 20 year term. Finally, it would cost almost $12,000 in interest over a 15 year term.
Saving that additional money by not having mortgaged that amount increases your returns significantly, it’s a double bonus! You get a better return on the $50,000 investment because of a higher yield, and you save money by not having borrowed that extra amount.
If you are considering a refinance I would also consider:
- your available capital,
- what returns you are getting in other investments,
- and measure how much more effective it may be to pay down your mortgage