For most home buyers, a mortgage is a smart idea, because, quite simply, it's the only way to afford a house. If you're in a position to buy without one, or to pay it off very quickly, dispensing with the mortgage and years of interest payments may seem like the smarter choice. Taking out a mortgage can be a good financial strategy, however.
If you pay cash instead of, say, taking out a $180,000 mortgage, that's $180,000 you don't have to invest. If you have a 4-percent mortgage rate and you can invest the money at 6 percent, you'll earn more interest investing the money than you pay out by taking the mortgage. The same calculation applies to making extra mortgage payments. If you can invest $10,000 in your 401(k) or IRA and get a better rate of return than your mortgage interest rate, that may be the smarter move.
Paying off your mortgage eliminates one mandatory monthly payment -- but it means you have less cash reserved for emergencies. If you don't have any money saved as a cushion against job loss or big medical bills, building several months worth of savings should be a top priority. It's particularly important if you aren't sure what your job or your life will look like over the next year. If you place it somewhere accessible, such as a money market account, it will earn interest for you as well.
Risk and Return
Investing your $180,000 instead of buying the house for cash makes great sense when mortgage rates are low. If lenders are charging fixed rates of 8 or 9 percent, or the market's rate of return flatlines, the advantage may lie with not having a mortgage. Investing the money is almost always riskier because investments can lose money. Paying off a $180,000 mortgage with a fixed 3.5 percent isn't much of a return, but the rate is guaranteed.
Another economic advantage mortgage advocates list is that you can write off the interest you pay each year on your taxes. The deduction benefits you a lot when you start out, but less as your mortgage ages, because more of your payment is principal instead of interest. The deduction is only available if you itemize on Schedule A instead of taking the standard deduction. As a result, many taxpayers can't take advantage of it.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.