Amid Low Interest Rates & Volatile Markets, a Fresh Look at Mortgage Payoffs

NEW YORK (MainStreet) -- Economic troubles in Europe, conflict with Iran and an uncertain presidential campaign season in the U.S. make the stock and bond markets look rather hazardous these days, so why not make a simple, guaranteed investment that can earn tens of thousands of dollars over the years, perhaps more? How do you do it? Simple. Just pay off your mortgage.

The mortgage payoff option has starkly divided camps of believers and critics. But as usual the truth is more nuanced. Assuming you have the cash on hand, the benefits of the payoff depend on both the homeowner’s circumstances and the prevailing market conditions.

A key condition of today’s market – extremely low mortgage rates – should give many homeowners pause when considering a payoff, as the amount saved in interest payments, which are historically low right now, might be eclipsed if that extra cash were invested elsewhere.

All else being equal, the payoff decision revolves around a comparison between the mortgage rate and the rate of return on an alternate investment. Pay off the final $100,000 on your 4% mortgage and you’ll save $4,000 in interest charges. If an investment in stocks would pay 7% (the historic average for investment in the stock market), that capital could earn $7,000, making the stock investment preferable.

Of course, the return on the mortgage payoff is guaranteed, while stocks are risky – if your stock tanks you could lose the entire amount you invested. That’s why many people prefer to compare the mortgage payoff to what could be made on an equally certain alternative like U.S. Treasury bonds. With the 30-year Treasury yielding just under 2%, the mortgage payoff would be twice as profitable.

Still, some homeowners may feel the risk of investing in the stock market is worth a shot. After all, market worries can create bargains.

“Mortgage interest rates seem to touch new lows every week, while equity valuations aren't outlandish by many measures, even after their three-year run-up,” writes Christine Benz, director of personal finance for Morningstar Inc., the market-data firm.

“Although out-earning one's mortgage interest rate might not have seemed realistic a decade ago, with 30-year mortgage rates higher than 7% and the market still working through post-dot-com-bubble valuations, doing so doesn't look so unreasonable today.”

Even some conservative experts forecast stock market returns exceeding 5% for the next seven years, she notes. (That’s 5% after inflation, or 7% if inflation averages 2%.)

An option to consider is to use part of your disposable capital to refinance the mortgage to today’s low rate, then invest the rest in stocks.