Many homeowners make paying off their mortgage early a financial goal. The allure of eliminating one big payment a month is strong, especially because it means you no longer have to deal with a mortgage servicer.
But paying off your mortgage early may not actually be the best financial strategy.
“People get so excited by how much money they can save by paying off their mortgages,” says Liz Weston, personal finance columnist and author. But, she says, it may not make financial sense for many people. “They have so many better uses for that money,” Weston says.
Before applying extra principal to your mortgage, or paying it off with savings, take a look at your entire financial plan. Are you fully funding your retirement accounts? Do you have an emergency fund? Have you saved enough for your children’s college education? Do you have health insurance, life insurance and disability insurance? Have you paid off your student loans and other debt? For most people, those financial goals should take priority over paying off a mortgage.
If you’re still carrying private mortgage insurance, it might make sense to pay down your mortgage to the point where you can ask to have that removed, but rising home values have helped a lot of homeowners in that area.
In recent years, mortgage rates have reached historic lows, and many people have mortgages at 3 to 4 percent. You’re unlikely to be able to borrow at such low rates again. Mari Adam, a financial planner in Boca Raton, Florida, recently refinanced her home mortgage into a 15-year loan at 3 percent interest.
“I’m going to keep that mortgage as long as I can,” she says. “I happen to like mortgages. … Rarely do I see cases where I think it makes sense to pay it off.”
She and Weston point out that while having significant equity in your home is great, it’s not always easy get to that equity if you need money. While you can theoretically tap it with a home equity line of credit, you may have trouble getting a HELOC if you are unemployed or retired and need cash, especially since lending standards were tightened in response to the foreclosure crisis. “You can’t get it out easily now,” Adam says. “Once you put it in your home, you may not get it out.”
For most people, getting your mortgage paid off before retirement is a good idea, as long as the rest of your financial house is in order. If your choice is between paying off the mortgage and putting the money in a savings account that pays minimal interest, eliminating a mortgage payment makes sense. “If you’re going to stick it into a bank account and earn zero, then pay it off,” Adam says.
But if you’re going into retirement with as much income as you had before, you’re getting a substantial tax deduction for your mortgage interest and you can easily make the payments, you are probably better off keeping the mortgage, she says.
Pulling money from tax-deferred retirement savings such as IRAs and 401(k)s to pay off a mortgage is certainly a bad idea because the tax you’ll pay on the money will exceed the interest you pay on the mortgage, says Todd Tresidder, a financial coach and author who publishes the Financial Mentor website.
For many people, being completely out of debt is an important emotional goal. In some cases, you’ll have to weigh that emotional desire against numbers that suggest you’re better off keeping your mortgage. Tresidder has a 5,000-word blog post about how to weigh using your money to pay off your mortgage versus investing it.
In a time of inflation, he notes, expenses go up but the cost of your loan stays the same, assuming it’s at a fixed rate. “When you pay off your mortgage, you lose one of the only hedges against inflation,” he says. “You don’t want to pay it off if the rate is below the expected rate of inflation.”
While the math strongly favors keeping your mortgage, emotion doesn’t always agree.
“Do you value maximizing your investments versus being out of debt? The math is clear. It’s a simple equation,” Tresidder says. But when you add in your values, “It’s whatever gives you the greatest satisfaction,” he says.
Here are eight reasons not to pay off your mortgage:
You’re not taking full advantage of your retirement accounts. Your first move should always be to contribute enough to your retirement accounts to get the full employer match. But you usually can sock away considerably more in a 401(k) or other tax-advantaged retirement accounts. That $100 you save today rather than put toward your mortgage will be worth significantly more 20 years from now. “There’s the value of compounding, which is huge,” Weston says. “How much can that money grow in that same period?”
You have other debts. Any debt at a higher interest rate than your mortgage should be paid first. Paying off credit card debt, student loans and even car loans should typically come before paying extra on a mortgage.
You don’t have adequate insurance. Anyone who is working needs health insurance and disability insurance. If you have dependents, make sure you have enough life insurance to support them if something happens to you. Insurance is usually a better risk management tool than paying off a mortgage, Tresidder says.
You don’t have an emergency fund. Everyone needs three to six months income easily accessible in case of an emergency, which could range from the need for a new furnace to medical expenses to paying living expenses if you lose your job.
You benefit from the mortgage interest deduction. Only about half of homeowners with mortgages actually benefit from the home mortgage interest deduction, but it does provide substantial tax benefits to some wealthier taxpayers. If paying off your mortgage throws you into a higher tax bracket, you don’t want to do that.
You haven’t saved for your kids’ college education. It does you no good to pay off your mortgage only to incur higher-interest debt to pay for college. Rather than paying extra on a mortgage at a low interest rate, you may want to add to the kids’ college funds.
You don’t have investments outside your tax-advantaged retirement accounts. If you have a mortgage at a low interest rate, you can probably get a higher return on your money investing in stocks or mutual funds, especially if your mortgage lowers your tax bill. Saving in Roth IRAs or regular brokerage accounts gives you money to use tax-free in your retirement versus money from an IRA that will incur a tax bill when you withdraw it.
You’re not doing things you enjoy. Paying off a low-interest-rate mortgage early at the cost of spending money on experiences such as travel, entertainment or more education isn’t the best option for most people. “Does it make sense to pay down that mortgage if it’s going to reduce your liquidity to do the things you want to do in your life?” Tresidder asks.
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Why Paying Off Your Mortgage Early Isn’t Always a Good Idea originally appeared on usnews.com
