Does it Make Economic Sense for Homeowners to Immediately Pay Off Their Mortgage?

BY busadmin  February 6, 2009 at 10:17 AM EDT

Wells Fargo; AP photo

Question/Comment: Given that U.S. banks appear to need cash to stabilize themselves and begin extending credit, would it not make economic sense for homeowners with mortgages to pay off the balance of their loans as soon as possible if not immediately? Would the short term rush of cash now be better than long-term, interest income forgone?

Paul Solman: A recent answer here suggested that paying down your mortgage, if you can afford to, may be a wise INVESTMENT move, especially if you’re in a low marginal tax bracket and wouldn’t dream of walking away from your home if it sinks underwater – if its sales price, that is, falls below the equity you have in it. That’s because most safe investment ALTERNATIVES pay less than you’d save by not having as big a mortgage.

But in answer to your question, yes, I guess if you pay off your mortgage the bank can then lend that money to someone else. As to the stabilizing effect, the bank would only be more stable if that someone else is more likely to pay back the loan than you are. That is, the bank’s stability depends on how dependable, as opposed to “toxic,” its assets – its loans – are.

As to the short-term rush of cash that would result from everyone paying off their mortgages, it will go right back into long-term interest income. That’s how banks make money.