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Wall Street Steward Blog

Leverage: The Eighth Wonder of the World

I know that financial experts say it’s best to be debt free, but when it comes to paying off a mortgage, that may not be the best move. Here’s why:

RECOVERING REAL ESTATE MARKET

Whether or not you believe that real estate is an appreciating asset probably depends on your perspective, but the truth is that it appears we’ve seen a short- term bottom in real estate prices, and are in the early stages of a recovery.

USE THE LEVERAGE

Assuming you agree that real estate is appreciating, remember that debt on an appreciating asset is a good thing because of the leverage involved. Consider two couples each owning a home worth $200,000. One family paid off their mortgage, while the other owes $160,000.

If that house appreciates by 10 percent, each couple’s net worth increased by $20,000, but their return on invested capital is very different. The debt-free couple only made 10 percent ($20k on a $200k investment), while the couple with the mortgage made 50 percent ($20k on a $40k investment). This is how utilizing leverage can help families build net worth.

TAX BENEFITS

Although I do not prepare taxes for a living, I like to consider the “net after tax” basis. The annual interest one pays on a mortgage loan is tax deductible, and that benefit must be considered. If the previously mentioned couple is in the 20 percent tax bracket and has a 3.5 percent, 30-year loan, their net after tax cost is closer to 2.8 percent.

Borrowing at a net 2.8 percent isn’t much of an expense, and there may be more profitable ways to use any extra than doubling up on the mortgage. In fact, you could potentially earn 6-7 percent by investing in a balanced portfolio of stocks and bonds, depending of course on your risk tolerance and the time invested.

CHEAP MONEY

Of course, everyone’s situation is different and it’s best to meet with your tax and financial advisors. But those are the reasons I believe in NOT paying off a mortgage early. Do you agree?