Mortgage Vs Stock Market

In 2003, mortgage rates as well as short term yields were at historically low. I also had enough cash to pay the mortgage resulting from my stock option sale in 2000.

When I bought my home, I had a 30 year loan at 5.8%. Six months later, I decided to go with a no cost 5/1 ARM with interest rate of 4.125%. My thinking back in 2003 was this:

• If you take into account mortgage interest payment deduction, real rate I would have to pay would be ~3%.
• I could make 3% or more in short term yield at that time.
• Over remaining 4 years, I would be able to generate more with the short term yield instruments.
• Once I approach end of 5 years when ARM reverts to higher rate, I would either pay it back or re finance.

Well in subsequent years, I have been able to use short term yield instruments like I-Bonds, treasury bills, Tax Free MUNIs, CDs, money market accounts, high yield accounts at ING, HSBC and most recently FNBOdirect and generate more return then cost of ARM.

July 2008 is when I will face the music. I am torn between three options:

• Pay off the mortgage
• re finance the mortgage and invest the money into equity market
  
• Pay off half the mortgage and re finance the other half. This means that half of the money will be invested in equity market.
  

There are many different opinions on this subject. Recently I came across an article by Ben Stein who suggests on investing rather then refinancing. Here is a link to the article.
http://finance.yahoo.com/expert/article/yourlife/37252

Many of my co workers and friends have been talking about peace of mind of not having the mortgage. I am not one of them. For me it is going to be strictly a financial decision involving things like risk/reward, asset allocation and rate of return. If mortgage interest rate hike up to 7%, decision will be a no brainer. I would pay off the mortgage as this would translate to risk free yield of 6%.

What are your thoughts ?

June 2007
tech-finance guy