One of the questions we get most as Financial Planners is, “Should I pay off my mortgage?” This is dependent on the individual or family’s current financial situation. In this short blog, I will break down some pros and cons for each person’s situations.
Diversification – Paying off your mortgage early without other types of investments concentrates your investment portfolio in real estate. Real estate is an asset class just like stocks, bonds, and other alternative investments. Make sure you have a diversified portfolio before paying off your mortgage.
Tax Savings – Using the money that you would be putting down on the house into Roth IRA’s, Traditional IRA’s, and 401k’s will save you in taxes, either in the short or long term. Paying off the mortgage will eliminate the potential tax deduction you have with the interest you are paying.
Rate of Return – Paying off a mortgage effectively gives you a guaranteed rate of return. If you are paying a rate of 3.75% for your mortgage and you pay it off, you are not paying that to the lender anymore. However, there is the opportunity cost to do this. What if you can get greater than the 3.75% somewhere else?
Liquidity – Paying off your mortgage early feels great! You no longer have a monthly payment, but you also no longer have access to the money you used to pay it off. If you access that money again, you most likely will have to do it with some sort of debt (i.e. a home equity loan) or by selling the home. This is why I recommend having a fully diversified portfolio before paying off your mortgage.
Age-Based Decision – When you are younger, you have the greatest asset of all on your side – TIME. The time value of money works far greater to your advantage for saving while you are young. If you are young, make sure you are saving 15% for retirement and funding your emergency accounts and non-qualified investment accounts before paying off your mortgage. If you can invest in the market that historically has returned around 10% per year, you should come out ahead almost every time. However, if you are nearing retirement, it can be beneficial to free up as much cash flow as possible. When you can use $100,000 to pay off a remaining loan balance that frees up $1800 per month (your mortgage), you are essentially creating a 21% yield for your cash flow. If you will be on a limited income stream, this can be a great cash flow maximizer. Check with your advisor to see where the best place is to put your money to get the best return.
Still wondering whether or not you should pay off your mortgage early? We would love to chat with you about all your financial options. We’re here to help you plan out your next big financial decisions, schedule an appointment today!
Jeremy Sharp is the Director of Financial Planning at Stewardship Financial. Jeremy loves helping people figure out ways to organize their financial life and make better decisions with their money. Jeremy and his wife have two boys and is an avid fan of New England sports.