When it comes to home loans, we're a nation of debt-a-phobes. It's easy to understand why -- we're still digging out from a credit crisis caused by too much (or mismanaged) mortgage debt. Not surprising then that borrowers are choosing shorter-term loans when they can; of those who refinanced a 30-year fixed-rate loan in the third quarter of 2011, 40% chose a 15- or 20-year loan, the largest percentage since 2003. And with high volatility and uncertain returns in the stock market, paying down your mortgage delivers a relatively generous, guaranteed return.
But many financial experts think the mortgage burners are misguided. "The 30-year fixed-rate mortgage is one of the great gifts to the American middle class," says planner Mark Helm, of Helm Financial Advisors, in Falls Church, Va. No one's suggesting that you load up on debt you can't afford -- we've been there, done that. But a long-term mortgage, at fixed rates so low you're unlikely to see them again in your lifetime, can work to your advantage.
A mortgage keeps your assets diversified, says Debra Morrison, a financial planner at Trovena, a wealth-management firm in Roseland, N.J. “I don’t recommend that clients prepay principal because I don’t want a disproportionate amount of their net worth tied up in their homes,” she says. Next, consider the tax break. Someone in the 28% tax bracket with a 4%, 30-year mortgage will average more than $1,300 a year in tax savings over the life of the loan, according to Bankrate.com, whittling the after-tax mortgage rate to 2.9%. Nothing in the stock or bond markets is guaranteed, but a well-balanced portfolio has a good shot of beating that rate of return in the long term, especially in a tax-advantaged account.
You can save a lot of interest by choosing a 15-year loan over a 30-year -- about $63,000 after taxes on a $200,000 loan for someone in the 28% tax bracket. But ask yourself whether you can really afford the higher monthly payment -- in this case, $1,420 versus $955. Have you maxed out your 401(k) and built up an emergency fund? Paid off credit cards? Funded insurance policies and, if you desire, college savings? If you haven't, choose the 30-year loan. And if you have, choose the 30-year loan anyway and put the difference between the two payments in a savings or investment account. You'll build up a nest egg that might keep you afloat (and in your house) if you lose your job or get sick. The strategy requires discipline; setting up automatic payments helps.
There are few better hedges against inflation than a mortgage. If inflation rises, so will interest rates. But you'll have borrowed at a low, fixed rate while savings rates climb and you'll pay the loan back with increasingly cheaper dollars. It's a deal even retirees can embrace, says Cambridge Connection adviser Bert Whitehead. But he concedes that a mortgage is a tough sell with that group.
That's because the decision to pay down a mortgage is 80% emotion, 20% math, says Jerry Verseput, at Veripax Financial Management, in El Dorado Hills, Cal. "The peace of mind that comes with being mortgage-free trumps the math. And the goal of financial planning is to reach a point where you’re not worried about money anymore."