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We Struck it Rich!

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Posted On: 03/09/2016

Question: We recently came into a lot of money. Does it makes any sense to use our once-in-a-lifetime windfall to pay off the mortgage? Some of our friends say we’d be better off investing the funds.

ANSWER:

With mortgage rates near historic lows, the effective cost of borrowing is remarkably small. And in most cases, you are able to to write off mortgage interest. And look ahead: you will be paying with dollars that buy less and less over time. Given inflation, if it continues, the real cost of borrowing becomes even smaller than it seems.

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Mortgage financing is so cheap that paying off a mortgage may not be a good economic decision, simply because in today’s market you’re not getting much of a return. If you pay off the mortgage you may have a hard time in the future should you need to raise cash and rates have gone up, your income has dropped or your property value has declined.

Keep in mind your best first step would be to use your new-found wealth to pay off higher cost debt, such as credit cards and student loans.

That said, there are some very good reasons to own a house free and clear.

Paying off a mortgage means you save the cost of interest each month. And with no mortgage bill to pay, your monthly cash flow will be significantly higher.

For example, if you have a $150,000 fixed-rate mortgage at 4 percent, the cost of interest in the first year is $5,952 or an average of $496 per month. The interest cost declines each year as the principal balance is reduced. With a fixed-rate loan the monthly payment for principal and interest remains constant, in this case $716.12 or $8,593 per year.

For many households, the big deal is not tax write-offs or maximizing the rate of return, it’s cash flow. Reducing monthly expenditures is especially important at a time when jobs are no longer so certain or so lucrative. You may simply prefer the comfort of a home that is mortgage-free.

Of course, your tax bill will go up without the mortgage interest write-off, but that cost can be paid from monthly cash savings. In addition, you can use the monthly savings to pay down student loans, high-cost credit card debt and car loans.

Perhaps you want a solution in the middle. If you have a loan and pay private mortgage insurance, ask the lender if the loan can be curtailed, or paid off more quickly, with extra or larger payments applied to the principal. Also ask if you can get rid of the monthly mortgage insurance payments. No PMI results in a smaller monthly payment.

If you chose a curtailment you may be able to reduce your monthly costs and keep much of your cash. The choice, of course, is up to you.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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