Why Opportunity Cost Ought To Be A Consideration In Your Money Decisions
Let's say you are in a situation where you have additional money to pay down your mortgage. Is it worth doing? The fast answer is that it depends. To arrive at a good answer, you need to consider the other alternatives that you have with that money.
For a start, there might be other opportunities available to you. I'm really not talking about the stock market or any other marketable securities. These have a tendency to offer low yields over long periods. The historical return for stocks has averaged around 6% during the last one hundred years. Therefore, if I had a choice between paying down my property versus purchasing stocks, I'd rather pay off the mortgage. In addition, the exchange is very volatile and returns can be noticeably less than their long-term averages over 10 to 15 year periods. We are in such a cycle now. If the rate on my mortgage is 6%, then I will not likely gain anything by employing the additional cash into stocks.
What if you had more opportunities than this? What if you were thinking about starting your own business? Clearly, there is more risk to that. Nevertheless, the return on your initial investment will likely be way higher than investing in securities. In that situation, the return on investment would be much greater than the total interest that you are required to pay on the mortgage. In this example, you're better off investing the cash rather than paying off your home loan.
The opportunity cost demonstrates that my returns are negative if I pay off my mortgage when I have better ways to invest the money. If you are counting on starting a brand new company, home equity is much cheaper than almost all of the alternatives. SBA loans, in particular, consist of higher costs as well as higher interest rates. This is because it's hard for lenders to value the collateral and default rates are high. When they take possession of the collateral after a default, it's much tougher to get rid of at fair valuation than a residential property.
Lastly, depending on your tax situation, the true price of borrowing could be below your interest rate. Since mortgage interest is deductible against tax for most taxpayers, the income tax savings could be considered in offseting the money you are paying in interest charges. Your tax savings depends upon what tax bracket you are in. So, if you are considering paying down your house loan, definitely look at all your other alternatives first.
Eileen E Jacobs is a loan originator in Las Vegas. home loan las vegas View her blog here: las vegas mortgage blog
