Monday, June 04, 2007

Why Paying Off Your Mortgage Early Might Be A Bad Idea

I work with portfolios of real assets. One of the basic concepts of portfolio analysis and management is that you must know what you value. Very seldom does an organization have one single goal that it pursues to the exclusion of all others.

It is a useful framework for looking at the mortgage problem that I wrote about earlier.

If your single goal in life is to minimize the amount of interest you pay in your life, paying off your mortgage early may be a good strategy. For most people their house loan is the biggest loan they will ever get, typically paying hundreds of thousands of dollars in interest over the life of the loan. These are big numbers, exagerrated by the size of the loan and the time period.

However, most people have goals besides minimizing the interest paid. If you take it up to a higher level, most people want to maximize their wealth, which in simple terms is simply money in minus money out. Money in that equation can represent any form of value including house appreciation, stock appreciation, etc. We normally also have other goals that are not financial. We look for things like free time, strong family bonds, raising healthy, happy children, pursue hobbies, travel, a circle of friends, health, etc.

In this framework, the mortgage interest expense is one part of the money out equation, which feeds into the wealth maximizing goal, which is one of many priorities that you have in your life.

In that framework, minimizing the interest paid on your house becomes a part of the overall goal of reducing costs (so you would probably choose to pay off your high interest credit cards first). That is a part of maximizing your wealth, so you might choose to invest the money instead. Then you have the less quantitative pieces of your portfolio goals--lifestyle choices, hobbies, family issues, travel, etc--any of which may have a higher priority than the financial ones.

All I'm saying is to sit back and look at the big picture before you make this kind of investment.

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