Oran Hall, Contributor
QUESTION: Is it wise to pay off a mortgage before the time allotted?
- Philip
PFA: It depends on the rate of interest on the mortgage, investment returns, and the remaining term of the mortgage. This is primarily an investment decision. The action you take must ultimately make you better off.
It is to your advantage to pay off your mortgage early if the interest rate on the loan is higher than the interest rate or investment rate of return on the funds available to pay it off.
If, however, you can earn more on those funds, after tax and expenses, than the mortgage costs you, it is to your advantage to invest your funds rather than paying off the mortgage.
Maintain payment
You may choose to achieve your objective by paying one lump sum. If you choose to pay in more than one lump sum over time, however, you may maintain your monthly payment at the original level and thereby reduce the term of the mortgage.
In the early years of your mortgage, the bulk of your monthly payment pays interest. This explains why the principal balance of your mortgage reduces very slowly in the early years. In the later years, the greater portion of your payment is used to reduce your principal balance.
The earlier you pay off your mortgage, the lower the cost of interest is to you ultimately. If you want to maximise the benefits of this action, invest the sum you would normally pay as mortgage each month. The earlier you start doing so, the longer the time over which it compounds and the higher the returns.
Considering that mortgage interest does not earn you tax credits, that you will most likely pay your mortgage from after-tax income, that you may be able to invest your freed-up funds to earn tax-free income, and that the earlier you pay off the mortgage, the faster your equity in your property builds up, you could have much to gain by paying off your mortgage early.
If you opt to pay off your mortgage before the time allotted, it is best to do so in the early years to gain maximum benefits. The nearer to the designated end of the term of the mortgage that you do so, the less advantageous it is.
Living above means
QUESTION: For the past four years I have been trying to pay off my credit-card bill but no luck at all. How should I go about doing it?
- D Kitson
PFA: I am assuming that you make partial payments on your credit-card bill when payment is due. You no doubt recognise that credit-card debt is not cheap though it is so easy and convenient to incur it. It is the first debt you should pay because it is so expensive. The answer to your problem is not luck at all.
living above means
If you keep incurring debt that you cannot service, it is clear you are living above your means.
There are times when individuals run into short-term cash-flow problems from which they soon free themselves. Yours is a chronic problem that you need to solve. This calls for austerity measures.
You must reduce your expenses, increase your income, or sell some assets to solve your problem. True, this may mean savaging your standard of living, but you must bite the bullet.
Decide not to incur any more debt until you have paid off the existing one. Put aside the credit card - cut it up if you must. Use cash instead. Make a shopping list and stick to it.
When last did you make a budget? It is time to make one and set aside a large chunk for debt servicing. If you live with family, make the casting of the budget a family affair and let every member commit to stick to it. Appoint a responsible member of the family as the financial manager. Have regular family meetings and account to each other. If you live alone, you should have a trusted person to whom you are accountable.
I suspect that a substantial portion of your debt is accumulated interest. Check how much interest your debt has cost you. Are there useful ways you could have spent or invested that money? It is much better to build up savings for purchases than to 'charge'.
Crisis situations require drastic actions. To free yourself from and remain free of debt requires discipline.
Oran A. Hall offers free advice and counsel on money management and personal finance.
