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Should I Pay Off my Mortgage?
By Tara Conti, CFP®

This is a common question we get as financial advisors. Below are some of my thoughts.

Do you want to pay it off?

Many people just hate having debt and cannot wait to be done with their mortgage. Having any debt is a burden on their mind.

On the other hand, some people see the mortgage as an avenue to get a tax break on the mortgage interest and want to take advantage of the terms of their loan so they can make more with their money invested in the market.

If you are in retirement and on a fixed income it may just feel better not to have this monthly obligation. Others want to do what makes the most logical sense. There is an emotional side to this question so pay attention to what feels right to you.

Currently with interest rates as low as they are and the recent returns in the stock market being what they have been, we believe right now it often makes sense to pay off your mortgage.

Think of it like this, if you ignore the mortgage interest tax deduction and your mortgage is at the rate of say 4.5% (most are between 4.5% and 7%) you can instantly “make” the full 4.5% on your money by paying it off more quickly. You must itemize on your tax return to take advantage of the federal tax benefit of deducting your mortgage interest. (Consideration of the tax deduction is discussed in more detail below.)

There is no money market fund or CDs paying that interest rate right now. If you think your money can make more than 4.5% in the market then you may decide to invest your money rather than paying off your mortgage. Over the long term you may make more than the 4.5% which is where your personal preferences and confidence in the market come into play.

But please do not forget that you need to pay taxes on those earnings (both state and federal). This means you would need to earn slightly higher than 4.5% to earn a NET 3.375% after state and federal taxes. Remember, you do not get a state deduction for mortgage interest paid.

What if you do itemize and deduct your mortgage interest?

Yes, there is currently a tax deduction for the interest you pay on your mortgage. Please note that removal of this tax deduction is one of the changes being discussed on Capitol Hill.

I believe most people overestimate the tax savings of this deduction.

The rule of thumb to look at the return you earn with the tax deduction is to subtract your marginal tax rate from 1 and then multiply that number times your mortgage interest rate. For example, if I am in the 25% tax bracket and paying 4.5% on my mortgage (1 - 0.25% = 0.75 → 0.75 * 4.5% = 3.375%.) If you were to pay off or pay extra towards your mortgage you would be earning 3.375% on this money which in today’s environment is a good deal.

Do you have the cash or excess cash flow to put towards the mortgage?

You must have access to cash to consider doing this. If you have a large cash position that you don’t want to put in the market or some excess cash that you want to put to good use, pre-paying your mortgage may be a recommendation for you.

Some clients explain to us that access to “cheap money” such as 4 - 5% mortgage rates is a once in a lifetime opportunity AND they feel over a 15 - 30 year time frame that they can earn more than 4 - 5% (after taxes). While this thinking may be rational, behavior economics also shows us that the majority of investors will not be disciplined and will simply spend most of the money thereby worsening their financial position with more debt.

Our experience shows that people spend the money they see and have available to them so I am a big advocate for automated savings.

One strategy is to automatically pay half your monthly mortgage payment every two weeks to decrease the amount of interest paid over the long term and make an extra month’s payment each year.

Another strategy is to take your monthly payment and divide it by 12 and then add that amount to your required monthly payment. For example if you pay $1,200 per month for your required mortgage payment the math would be $1,200 / 12 = $100 → $1,200 + 100 = $1,300 per month.

Obviously increasing your payment by any amount will increase your equity more quickly and decrease the length of the loan and the amount of interest you will pay.

Caveats

Several caveats must be noted before paying off mortgage debt more quickly:

1. Get rid of any credit card debt first. The interest you are paying on the credit card debt is probably higher than that of your mortgage.
   
   
2. Make sure you have a 3 - 6 month emergency fund of cash set aside before you begin paying off your mortgage more quickly. You want to have access to liquid cash for any unforeseen emergencies. The equity in your mortgage is not easily or quickly accessible.
   
   
3. If you know of large cash expenditures in the near future (purchasing a car, wedding, college tuition, etc.) it probably makes more sense to keep a large cash position earning very little so you have access to this cash when needed.
   
   
4. Paying off your mortgage is not for everyone yet it does make sense for certain people.
   

Hopefully this article provides you with some information to help you think this through for yourself or with your financial advisor.

Happy Holidays!!!

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