Should I Pay Off My Mortgage Early?
by
Dale C. Maley
SMASHWORDS EDITION
PUBLISHED BY:
Artephius Publishing on Smashwords
Should I Pay Off My Mortgage Early?
Copyright © 2010 by Dale C. Maley
All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise) without the prior written permission of both the copyright owner and the above publisher of this book.
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Table of Contents
The Great Depression
Conventional Financial Planning Wisdom
Federal Income Tax
Case Study of 40 Year Old Married Couple
Case Study of 55 Year Old Married Couple
Case Study of a 65 Year Old Married Couple
Financial Experts Weigh In
Lack of Financial Education in America
Behavioral Finance
Summary
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Warning-Disclaimer
This book is designed to provide information in regard to the subject matter covered. It is sold with the understanding that the publisher and author are not engaged in rendering legal, accounting, insurance, or other professional services. If legal or other expert assistance is required, the services of a competent professional should be sought.
It is not the purpose of this manual to reprint all the information that is otherwise available to the author and/or publisher, but to complement, amplify, and supplement other texts. You are urged to read all the available material, learn as much as possible about investing and to tailor the information to your individual needs.
Every effort has been made to make this book as complete and as accurate as possible. However, there may be mistakes both typographical and in content. Therefore, this text should be used only as a general guide and not as the ultimate of investing information. Furthermore, this book contains information on investing only up to the printing date.
The purpose of this book is to educate and entertain. The author and the publisher shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this book.
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The Great Depression
The 1930’s in the United States was a desperate time. The stock market crashed in value by 89%. Unemployment reached 25%. These tough times lasted through the whole decade of the 1930’s, not just two or three years.
One of the reasons the 1920’s were known as the Roaring Twenties was that investors were able to buy stocks with just 10% down. [1] Wall Street loaned the investors the other 90%.
The ratio between the asset values you own versus the amount you invested is often called leverage. For example, if you put $20,000 down on a $100,000 home, your leverage is 5:1 (100,000 divided by 20,000). The 1920’s stock market investors were highly leveraged at 10:1 since they only put 10% down. Lehman Brothers, which had to close its doors in 2008, was leveraged 30:1.
When the stock market crashed on October 29, 1929, brokers demanded that their clients pay back their stock purchasing loans. The investors had no choice but to go to their banks and withdraw whatever cash they had. Quickly, the banks ran out of cash.
The bankers panicked and demanded that homeowners and farmers immediately repay their mortgage loans (which they were allowed to do under the law in effect at that time). Those 30 year loans were due in full immediately. Millions of American homeowners and farmers were forced into immediate foreclosure.
Many farms were sold at foreclosure auctions. Sometimes, neighbor farmers would band together and only bid a maximum of a few pennies for the farm and equipment. [2] After the auction was over, the successful bidder would sell the farm back to the original owner for a few dollars.
The result of this experience was that millions of Americans, unable to pay off their loans, lost their homes and farms to foreclosure. Thus the lesson was learned: Americans learned that you must own your home outright, with no mortgage…….for that is the only way you can be sure you’ll never lose it. This mantra was indelibly etched into the
American psyche. As a result, our parents or grandparents told each successive generation that mortgages should be paid off as soon as possible.
But the Great Depression caused many financial reforms. Today, the minimum down payment on buying a stock is 50%, not the 10% of the 1920’s. [3] Mortgage holders can no longer immediately call a mortgage due and payable. If you make this month’s payment, the bank can do nothing but wait for next month’s payment. Therefore, carrying a mortgage does not carry the same risk today as it did in the 1930’s.
However, the Crash of 2008 brought mortgage foreclosures back into the limelight. Millions of people took on mortgages they could not make payments on. Banks and Investment Banks became highly leveraged (Lehman Brothers at 30:1) such that just a 3% decline in home prices would cause the whole house of cards to come tumbling down.
There is still risk in holding a mortgage as evidenced by the Crash of 2008…….it is just a different kind of risk than we experienced in the 1930s.
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Conventional Financial Planning Wisdom
Over the last 30 years, the conventional financial planning wisdom has been to not pay off a mortgage early.
The rationale goes something like this. Let’s assume you are in the 30% federal tax bracket. The after-tax cost of a 6% mortgage is only 4.2% (70% of 6%). If you invest this money in the stock market, your after-tax return will be 70% of the 10% average return of the market……or 7%.
So, you earn the spread or difference between 7% and 4.2% or about 3%. If you get a $100,000 mortgage, you earn an extra after-tax income of 3% on the $100K, or $3,000 per year.
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Federal Income Tax
In the U.S. federal tax code, you first add up all of your income. Then you subtract the standard deduction or itemized deduction, whichever is higher. The tax rate is then applied to the remainder.