Republished from NYT Real Estate March 18, 2007 By BOB TEDESCHI
As many homeowners dip into their home equity, a small but growing number are doing the opposite – paying off their mortgages quicker than lenders require. But is ending a mortgage sooner than necessary a wise move? There’s no simple answer. Financial advisers disagree sharply about whether, and when, such an approach makes sense.
“I talk with clients about this every day, probably five, six times a day,” said Jonathan Satovsky, an investment adviser in Manhattan with Ameriprise Financial, a financial management company based in Minneapolis. Mr. Satovsky generally warns his clients against prepaying.
First, he said, assuming that the homeowner has a 6.25 percent fixed-rate mortgage and is in the 20 percent incometax bracket, the net interest rate – after mortgage interest is deducted on tax returns – is about 4 percent. Although homeowners would save that 4 percent by paying off their mortgages, he said, they would earn more than 4 percent interest if they invested the money instead. “There might be periods where the markets go backward, and you think it’s a mistake,” he said. “But over 10, 15 years, they’ll earn a lot more by not prepaying.”
In addition, he said, because mortgage interest is front-loaded, the interest deduction drops sharply in the later years of the mortgage. Andrew Schweitzer, the chief executive of the Gulfstream Financial Corporation, an advisory service in Sunrise, Fla., disagreed. “The goal should be to free up earned income so you can accumulate it for retirement,” he said. “If I’m paying $24,000 a year on a mortgage, I may have saved $8,000 a year in taxes. But if I didn’t have a mortgage, I would have saved $24,000 in overall expenses. It’s not rocket science.” By clearing the debt earlier, you pay much less over all in interest over the life of the loan, and free that money for
Mr. Schweitzer’s company sells a service that essentially uses clients’ money to pay bills on their behalf, choosing debts with the highest interest rates first. Typical clients, he said, have about $120,000 in annual household income and carry about $120,000 in debt, from cars, mortgages, home-equity credit lines and credit cards.
With the service, Mr. Schweitzer said, assuming the clients spend the same amount but stop using credit cards, their total debt, including mortgages, is typically paid off within eight years. The average client, he said, saves about $200,000 in interest by paying off the debt in less than the full period allowed and pays Gulfstream $1,500 for the service.
Clients can save and invest their money for retirement, he said, and achieve financial independence more quickly than they would have while carrying debt. (There is an important caveat – some mortgages carry prepayment penalties, which can total thousands of dollars, so borrowers should check with their lenders for details.)
Other services offering guidance, like P1asticEconomy.com7s Track Cards, help homeowners choose which debts to pay off first but do not manage the client’s money directly and typically do not include mortgage payments. Should homeowners choose to prepay their mortgages, Mr. Satovsky of Ameriprise suggests they take out a homeequity line of credit before they begin. “Prepaying is dangerous,” he said, if the homeowners’ equity is completely locked into the valuc of the house and they are not disciplined savers. “You could have $2 million in equity in the home and say you’re ready to retire,” he said. “I say: ‘Great! What will you live on? Social Security? You spend $20,000 a month.’ ” If the homeowner then becomes disabled or unemployed, he may not qualify for a home-equity loan when he needs money, Mr. Satovsky said.
Copyright 2007 by The New York Times Co. Reprinted with permission.