02/12/08: Paying Off Your Mortgage
By Benny L. Kass
Q: Our condominium unit is now worth approximately $350,000, and we owe only $25,000 on our mortgage. We are from the old school, and want to own this property free and clear. We have the money, and are considering paying off the loan. Is this a good idea, and if so, how do we go about making sure that it is done correctly?
A: The old school is a reference to our parents (or grandparents) who lived through the recession in the 1930s. Because the stock market crashed, and lots of people were unemployed, those who owned their home free and clear of any debt at least had a roof over their head and did not have to sleep in the streets or under the bridges.
There are many people today with this same mind-set, and while I personally disagree with this concept, I certainly respect and understand their views.
Let me play devil's advocate. You have $325,000 in dead equity. This is the difference between what your property is worth and what you currently owe. Three or four years ago, your condominium unit probably increased in value between 10 and 20 percent, if not more. In todays market, the value of your home has probably decreased slightly, although some recent statistics about the District of Columbia indicates that while sales have slumped, last year property values have nevertheless increased by about 10-12 percent.
Appreciation is not dependent on whether you have a mortgage or on how much you owe on your home. The house will increase (or decrease) in value regardless of whether you have a mortgage. Thus, in my opinion, the money you have in your property -- which we call "equity" --is just sitting there; it is "dead equity".
You now want to take $25,000 out of your savings and pay off the loan. Why? You are getting some small tax benefit from the interest deductions and presumably you are getting a decent rate of return on your investments. Other than the satisfaction of owning your house free and clear, I do not see any benefits by paying off that mortgage.
In fact, I would recommend that you consider refinancing. Interest rates today are comfortably low, with the national average for a fixed 30 year loan hovering around 5.5 percent. You could, for example borrow $100,000, pay off your outstanding debt, and after paying closing and settlement costs walk away -- tax free -- with approximately $73,000. The monthly mortgage payment on this loan (at 5 5/8%) would be $575.66 -- which is probably close to what you are currently paying. And because this is a new mortgage, your interest deductions would be larger.
For example, if you are in the 28 percent tax bracket (i.e. married, filing a joint tax return and earning less than $200,300 per year), this would provide you with a monthly deduction of $161.18 (or $1,934 yearly), and your real monthly payment would only be $414.47. (Note: unless the money you borrow is used to improve your property, under current tax law you are only able to deduct interest in the first $100,000 when you refinance your current mortgage).
Many readers will challenge me. They will point out that it makes no sense to pay 5.5/8 on a mortgage and only be able to get 4 or 5 percent interest by putting the refinanced money in a savings account.
I do not disagree with this. But over the years, I have had too many clients from the old school who are "house rich and cash poor". They own their house free and clear but do not have sufficient money to pay the increasing real estate taxes or the insurance premiums. I firmly believe that everyone should have money in the bank -- even if it does not pay a lot of interest -- for that rainy day,.
If you still want to pay off your mortgage, here's what you should do.
First, make absolutely sure that there is no prepayment penalty attached to your loan. Because your loan is so low -- and you have had the mortgage for a number of years -- I doubt that there is such a penalty, but you have to confirm this. When you first obtained that loan, you signed two important documents: a promissory note and the Deed of Trust (also known as a mortgage). The terms and conditions of your loan -- including any prepayment penalty -- will be spelled out in those documents. Read them carefully. If you have trouble understanding the legal language, discuss the situation with your lender or your lawyer.
You should send a formal written request to your lender asking for a payoff statement, and advise the lender of the exact date that you expect to send in your payment. The lender will advise you of the outstanding balance, and will also provide you with the "per diem" interest.
Mortgage interest is calculated in arrears. So when you make your February payment, for example, that will pay the principal and interest that accrued during the month of January. For most loans -- other than those insured by the Veteran's Administration (VA) -- you can pay off your loan at any time. Example: Assuming you made the February payment, the payoff statement will indicate the principal balance as of January 31, and it will also tell you what the daily interest will be. Since you plan to pay it off on February 23, multiply the per diem interest by 23, and add this amount to the outstanding balance.
Keep in mind, however, that interest will continue to accrue to the time the lender actually receives your check. So I would add 10 additional days of interest, just to be on the safe side. All legitimate mortgage lenders will refund any excess payments to you.
If you have a mortgage insured by the Veteran's Administration (VA), to my knowledge, that is the only loan that requires you to pay a full month of interest. In that case, try to coordinate your payment so that it reaches the lender by the end of the month.
What about any escrows that your lender is holding to pay real estate taxes and insurance? The payoff statement should advise you of the amount being held in escrow. Some lenders will deduct this amount from the outstanding balance; most lenders, however, will send you a separate check for this amount after you make your final payment.
And don't forget to advise both your real estate tax office and your insurance company that you will now be responsible for these payments. I recently represented a lawyer who paid off his loan, but forgot to advise the taxing authority. It was only when he learned that his house was about to go to tax sale that he was able to resolve the situation.
When you first got your loan, the Deed of Trust was recorded among the land records in the jurisdiction where your property is located. Now that you have paid off the loan, you want to make sure that it will be released from land records. Some jurisdictions require that a Certificate of Satisfaction be recorded, while others use a Deed of Trust Release.
Your lender will either arrange to record the release or will send it to you for recording. Either way, you want absolute confirmation that the release has been accomplished. This means that you want proof of recording, which you can get from your local recorder of deeds.
Finally, your lender should return the original Promissory Note, marked "paid and cancelled". The note is known in law as a "bearer instrument". This means that anyone who has that document could claim that you still owe the money. While this is not a major problem, since you will have proof that you paid off the note, why ask for trouble? Make sure that the lender returns the note to you.