- The Washington Times - Friday, December 14, 2001

I don't know if it's the economy or if people suddenly see the benefit of being debt-free, but there seems to be a lot of discussion lately about paying off a mortgage early.

Is this a good idea or not? There are two schools of thought on this question, and I'm not quite sure which is better.

For me, having been down the "barely making it" trail, I'm all for being debt-free. Pay it off as fast as you can but within financial reason. Don't make yourself so cash poor that you don't have any money to maintain the house, save for your retirement or enjoy your life. Even though it may be a drawn-out plan, a 30-year mortgage is a financial plan for owning your home.

Some financial planners would encourage you to have a mortgage even a big one (www.ricedelmen.com), while others give you plenty of ideas on how to get rid of it as soon as possible (www.crown.org).

It comes down to what you can do financially. Financial planner Ric Edelman makes a compelling argument for hanging onto the mortgage and using the extra money to invest in your emergency fund or other investments. He plays out a scenario using fictitious homeowners. One wants to get completely out of debt and uses all of his savings to lower his mortgage amount and then throws his extra money toward the principal. The second takes on a higher mortgage with a longer term and smaller monthly payment. So what happens if they lose their jobs? Obviously, the buyer with the higher savings account is better able to weather the downturn.

Another issue to consider is how much money you could make from the extra payment you're sending to your lender. With some online calculators (www.financenterinc.com/products/savings.html) and mortgage calculators (www.decisionaide.com), I think you'll be able to determine whether the early payoff eventually results in a bigpayoff financially.

For the house priced at the national average, $154,000, assuming a 5 percent down payment, 30-year fixed-rate mortgage at 7 percent, along with a savings investment averaging 8 percent per year, here are some calculations on both scenarios. The monthly principal and interest payment is $973.34, and the principal loan amount is $146,300.

First, let's look at taking that extra money and placing it in a savings program instead of reducing your mortgage. Most people think about adding just an extra $100 to the payment, so let's use that amount as both the investment amount and the debt-reduction amount.

With the Finance Center Inc. calculator titled "How Much Will My Savings Be Worth," $100 saved per month in an investment yielding 8 percent would result after 30 years in earnings of $60,354 in a taxable investment and $81,020 in a tax-deferred or tax-exempt investment. At the end of 30 years, this same homeowner will have paid out the $146,300 principal amount of the loan as well as $204,098 in interest.

Now, let's take that $100 per month and plop it onto the principal of the loan, resulting in a monthly payment of $1,073.34. Here's what happens: The term of the loan is cut by 7.25 years, saving the homeowner $57,859.85 in interest payments.

Here's the second step of that scenario. Take the monthly payment amount, that $1,073.34, and start placing it in an investment plan just like we did earlier with the $100 except the model here saves only for the remaining 7.25 years left from the original loan.

By saving $1,073.34 per month at 8 percent over 7.25 years, a homeowner would have $100,921 in a taxable investment or $107,117 in a tax-deferred or tax-exempt investment. This doesn't include the interest payment savings of $57,859.85, which actually is a paper savings.

Keep in mind that by cutting out the interest payments, the homeowner also loses tax deductions in that same amount, which could result in a new tax bill over those 7.25 years of $16,200.78 but the owner still has $9,896.24 to the good over that period because of not paying out the larger amount of interest. The savings come from the $107,117 tax-deferred investment over 7.25 years, minus $81,020 the $100 per month investment for 30 years which results in $26,097. That's the gross savings. Because you reduced interest payments by $57,859.85, the tax bill on that amount at 28 percent will be $16,200.76. Subtract the $16,200.76 from the $26,097 to get the savings of $9,896.24.

As with any tax deduction, you have to spend the money to get the deduction. Why spend $1,000 to get $280 in savings for homeowners in the 28 percent tax bracket? Sometimes it just doesn't make sense.

These are pretty impressive numbers. However, I must point out that the average homeowner chooses to move every five to seven years instead of staying in the same house and allowing these numbers to come to fruition.

So, should you pay off your mortgage and go for the gold debt-free ring? The real question is, will you?

M. Anthony Carr has written about real estate for more than 12 years. Contact him by e-mail ([email protected]).

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