After having saved for your retirement and putting money away for your children's college expenses, the next thing Dave Ramsey suggest doing is paying extra on your mortgage, and paying off the home early.
To start with, Ramsey suggests getting no more than a 15 year fixed rate mortgage, that is no more than 25% of your income. If you don't already have a 15 year fixed mortgage, now may be a good time to refinance your home. A 15 year mortgage may mean higher payments, but it also means you'll be paying the loan off earlier, and you'll be paying less in interest. Pay it quicker that 15 years, and you'll save even more because most of the interest is paid at the front end of the loan period.
By paying off the mortgage early you're also going to be giving yourself a huge peace of mind knowing that your house is paid off, and if the worst happens, you'll be able to get by on a whole lot less. After all, the house is paid for!
There are a lot of arguments surrounding this baby step, and whether it really is the best thing to do psychologically and financially.
Points in favor of paying off the mortgage early:
* Interest Savings: You'll be saving thousands of d0llars in interest payments on the mortgage. For example, on a 200,000 dollar mortgage over 30 years, with an interest rate of 6%, you'll end up paying over $250,000 in interest. Cut that to a 15 year mortgage and you're only paying $115,000 in interest. The faster you can pay the mortgage up front (when you're paying the most interest), the less interest you'll pay!
* Less Risk: By prepaying your mortgage you'll have less risk in your life because you'll have a paid off house. When you have a paid off house you have a lot less to worry about because you know you'll at least have a place to live as long as you cover the few bills you have left. Plus, trying to beat the the benefit of pre-paying the house by investing the extra money instead means added risk because investing isn't a sure thing.
* Peace Of Mind: Having a paid off house means having peace of mind. I don't think the importance of that can be underestimated. Having debt of any kind can really be a extra weight on your shoulders, and it can weigh you down. Don't underestimate the psychology of personal finance, and that burden is very real. Remove it and you will feel a lot more free to save, invest, build wealth and give!
* Less Stress: You'll have less stress when having to deal with a job change, or wanting to have a spouse stay home to raise the children. Because you have a paid off house you'll only have a few small bills to worry about. You'll have walkaway power – power to walk away from any job you don't love or enjoy because you only have minimal expenses!
* It's Like Getting A Raise: Without having to pay that large bill every month, it's like getting an instant raise! You can take the extra money every month -and start investing!
Take someone who is in his mid-thirties and paid his mortgage off completely. This allowed his wife to quit work and stay at home to raise their three children. They have no other debts, and he recently took a lower paying job because it brought him more satisfaction at the end of the day. He wasn't trapped by an enormous mortgage, or saddled with other debt. Being debt free allowed his family to make these decisions to live the life they want to live, not live the life they are force to live to just to repay debt.
Being debt free brings freedom, and sometimes that's better than a few extra dollars made through investments.
There might be a good argument against paying off the house. Some of the better ones:
* Liquidity And Flexibility: By not prepaying your mortgage and instead investing the money, you are more liquid in your holdings. Your money is more accessible if it is in investments as opposed to in a house. This can give you some flexibility if you need the extra money. Of course, having your 3-6 fully funded emergency fund should preclude needing any large amount of money right away.
* Investing Returns Could Be Higher: If your expected returns on your investments will be higher than the interest and money saved by pre-paying, investing instead of repaying may be the better choice.
* Inflation Works With You: As inflation goes up by 3-4% annually, by not prepaying you are in essence paying less for the house every year. You pay the same in 2040 to live in your house as you are in 2010. So basically you're getting more for your money as time goes on.
* Lack Of Diversification: One could argue that paying off your house first means you're investing in only one type of asset, and unnecessarily means more risk. Better to invest in good mutual fund where your holdings are diversified, instead of investing in only one thing, real estate.
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