Here are my numbers: I bought a 130k condo fixer-upper. I paid cash. (I had to when I bought but I could have been financed in three months after January taxes were filed for my company. An oddity with the new FNMA guidelines for going to work for someone else for about a year.) If I financed 80%, that would have been a 104k mortgage. Add ~2% of the mortgage amount to the purchase price for closing costs that I did not have for paying cash -> 132k total. The mortgage amount is too low so you pay about an extra 1/2% on the interest rate. Looking at Bankrate.com today, it says about 4.4%. Interest and property tax are too low to make a difference when itemizing deductions so standard deduction. This means that I pay this interest with after-tax dollars.
Suppose I invest the 102k (minus the closing costs that are above cash sale closing costs) and earn 8%. My marginal tax rate is about 40%. If I can keep it invested and not pay taxes until later, this has a difference because I can compound before paying the interest. I have a problem getting dividends when I don't want them. Let's just suppose I liquidate in a year. (I know this assumption has big changes to the numbers, but the assumption that you won't sell or have dividends in the other calculations are the opposite extreme.)
Mortgage Interest: 4.4% x 104k = 4576.
Investment Estimated Payout: 8% * 102k * 60% = 4896.
Profit = $320
For me and my numbers this savings is not enough to make a difference. My savings rate is about 5k/month so this isn't going to add up that quick. I don't plan RE, but I could in about 4.5 years following normal statistical charts for the stock market. If I do retire, then stock market volatility comes into play. There is a real cost to taking the money out of investments on low years and high years to pay a fixed investment. They do not even out. The higher the volatility the higher the real cost.
If you spend more on a home than I did, that is a probably a luxury. (I know this is COL dependent but I'm not in a cheap area. The average condo price in my area is about 400k. Homes are about 800k. I just have one that looks like an apartment and nobody wants them in the luxury area. Also, my final cost was 170k after renovations.) My savings by buying a cheaper condo will by far outweigh anyone who spends enough to benefit from itemized deductions.
To be clear, I'm not arguing that keeping a mortgage is better financially. Even in my situation with a low home value & high marginal tax rate on investments I come out ahead. A lot of the theoretical formulas break down in the real world though. Just some additional things I can think of...
- If I have a late payment, an additional fee.
- I need to keep more money in my non-interest bearing checking account to cover higher monthly expenses.
Another thing, this comparison is the difference between paying cash or financing. 2% of the mortgage amount has already been paid if you have a mortgage already. I see no reason to pay it off early.
To each their own, but I'm happy with my decision. Some additional factors for me are that most of that money was made flipping homes. Additionally, I've never lived anywhere longer than 3 years so closing costs add up.