Thursday, May 22, 2014

The case for paying off your mortgage

Just reading, which had an article about whether buying or renting is better. They're saying that now that the housing market is perhaps over-inflating again (seriously, people, what the heck?), it's often better to rent than to buy. Overall, I would have to agree with that in most cases, not just by the raw numbers, but because people always underestimate the costs of maintaining a home (which are absurd–costs like $2K just to cut down a tree, etc.), and because people don't factor in the time and hassles associated with home maintenance as well. To the latter point, I think homes are best thought of as a hobby for the home improvement weekend warrior. Not my kind of thing.

But let's say you have kids, and, sigh, you own a house. A common bit of financial wisdom is that, especially when mortgage rates are low, you should take out a big mortgage and pay it off slowly, because you can invest that money and make more with it. Roughly, the argument is that if your mortgage costs you 4% interest and investing nets you 5% return, well, you could be making 1%. There are some problems with this thinking. First off, one of the common arguments for it is that you save a lot on taxes because mortgage interest is deductible, so the effective cost is actually lower. True. But what every calculator I've seen fails to take into account is that you're only saving the difference between the itemized deduction and your standard deduction. If you have a family, which is probably often the case for people who own a house, then your standard deduction is pretty sizeable. Let's say that your mortgage interest costs you $15K per year, but your standard deduction is $12K. Then the real savings on your taxable income from the mortgage is just $3K, NOT the $15K that the most use in their calculators. If your tax rate is 25%, then this is $750–not chump change, but not really a game changer in the grand scheme of things, and much less than the $3750 you would calculate without thinking about the standard deduction. (It is also true that this becomes less of a factor the bigger your mortgage is, another reason why the mortgage interest deduction is such a regressive policy.) The other thing is that your investments are taxed, which many calculators also don't take into account.

The other problem with considering investment return is that the actual return is, of course, unknown. On average, your investment will probably go up, but it's highly dependent on the details, even in a 30 year horizon. Look, if you gave some Wall Street-type a GUARANTEED rate of return of, say, 4-5%, you can bet your life they would invest in it (and, in fact, they do). What's the interest rate on your savings account? Or even your CD? Almost always less than 1%. So the banks are basically saying that they can only offer you a guaranteed return of well under 1%. What accounts for this spread? One factor is that little market inefficiency called, you know, bankers' salaries. The other is the fact that not everyone pays off their mortgage, so there is some risk that the bank takes on. But if you believe in your own ability to pay off your mortgage, then it's a guaranteed return: every dollar you put in will earn you roughly 4-5% per year without fail.

Also, for most of us, sitting around and calculating this stuff all day is just about the least interesting thing we could do with our time. As Gautham says, peace of mind is the only thing worth anything in this world. Most readers of this blog probably choose to push themselves out of their comfort zone by pursuing science, and have precious little mental energy to waste worrying about other stuff. So whatever, just sign up for autopay and forget about it. Better yet, just move into an apartment.

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