Mortgage amortization: when does it pay off and which method is the best?
As a homeowner, you will have to decide sooner or later whether to keep your mortgage or amortize it. To do this properly, you will have to calculate the amortization and set up a precise payment schedule. Most mortgage holders opt to leave their mortgage outstanding so they can take advantage of the tax benefits. However, even though there may be a gain from the mortgage tax savings, this is not always the case. So all mortgage holders should calculate their amortization options and seek detailed financial advice.
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When is amortization worthwhile?
Whether or not amortization is worthwhile is a fundamental consideration, and the decision will depend on a number of factors. Should you decide to amortize, you must also understand that the accumulated capital cannot be used for other purposes, especially after your retirement. Essentially, you will need to quantify the tax implications of amortization and compare this with the level of returns which might be expected if your money were invested elsewhere. The judgement about what level of mortgage debt could be funded primarily depends upon how the capital available for amortization is invested. In that respect, the following three factors are of critical importance:
- Your marginal tax rate: How much tax do you pay on additional income?
- Your mortgage interest rate: What are your interest payments, and how much of your tax savings are directly attributable to mortgage interest?
- What alternative form of investment will you choose for your money, and how much return will you earn on that investment?
If you decide against amortization, your invested capital must generate more long-term returns than the mortgage costs. This usually implies investment in equities or similar assets which, in order to generate sufficient return, do carry a certain element of risk. Those who are risk-averse would thus be better off with amortization rather than investing in something akin to a savings account which earns a nominal rate of interest.
Should you amortize your mortgage or invest your money elsewhere? Our amortization calculator helps you find out!
With direct amortization, the mortgage is repaid to the lender in regular installments. Your mortgage interest costs will decrease after each repayment, but this will also gradually reduce your tax advantages.
With indirect amortization, your mortgage debt stays the same, and thus your mortgage interest costs likewise remain unchanged. Instead of regular repayments, regular savings are paid into a pillar 3a account. However, the capital thus invested is pledged in favor of the lender and must be used solely for repayment of the mortgage (no later than when you reach retirement age).
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