Debt is usually considered a bad thing. Many financial gurus argue that people should pay off all debt before really getting into the process of saving money. Are they right? Is all debt bad to have? Should people pay off a home mortgage with additional payments on the principle each month, or should they rather invest the extra money?
The answer to this question lies in the relative merits of not having a mortgage payment vs. the compound interest that an individual or family might realize by investing the additional money used to pay off the mortgage early. Much of this argument centers around mortgage rates. How high are mortgage rates? Right now, home mortgage rates are at levels that are unheard of in post-World War II America. For the past year or so, a 30-year fixed rate mortgage has had an annual interest rate of around 3.5 percent. For the past several years, the average has been between 4 and 6 percent for those who have good credit.
To give a good example why it might be better to invest money rather than pay down a good mortgage with a favorable rate, the recent bull market serves quite nicely. Since the market low in March 2009, the major stock indices have more than doubled. Someone who decided to put all additional money toward paying down a mortgage with a 5 or 6 percent interest rate would have saved a corresponding amount of money in interest. For example, this additional payment might have been $200 per month. In this hypothetical situation, the additional money paid out would have been $2,400 in 2009, and it would have saved very little in terms of interest payments. That same money invested in the stock market would probably be worth well over $5,000 today.
A home mortgage should always be the last debt paid down early. The reason for this is that it usually has a lower interest rate because of the lower risk associated with a mortgage. Most people will do all they can to keep a home even when they might miss a credit card payment. Credit card debt usually has a much higher interest rate, so it should be the first to be paid off. Another reason why paying off a home mortgage should be a lower priority than saving money or investing is the positive tax benefit that having a mortgage provides. The interest paid on a home loan is actually deductible from taxable income. This means that those who have enough interest to itemize will actually save on their taxes by keeping the home mortgage.
Saving money or investing money can be difficult. Many people think that paying off all debt immediately is a good idea. Unless there is a high interest rate on the debt, investing should take priority. Being debt free is great, but a home mortgage will not usually have an interest rate that causes an outgo of money that is greater than the historic return of the stock market. The tax benefits of a home mortgage also make investing a more attractive option.