Should You Pay Off Your Mortgage Early?

Let’s pretend you had $200,000 to invest for the next 7 years. Would you rather take a guaranteed total return of $14,274 or would you trade that amount for the possibility of earning $101,799? Your answer probably depends on how you feel about risk, the amount and types of your other investments, your timeframe for spending the money and, in the case of the latter investment, the probability of ending up with the larger sum or some other amount.

Lately, we’ve been getting a few different versions of the same question. Should I pay off my mortgage early? It’s a question that’s been around for as long as personal finance and mortgages have coexisted. Often the question will come from a young couple considering paying a little extra towards their mortgage each month in an effort to shorten their payback period. Other times, it comes from someone nearing retirement. Maybe they’ve received or accumulated some cash and they’re wondering whether they should invest the money or use it to pay off their mortgage.

Like many personal finance questions, this one has no one size fits all answer. That’s part of what makes personal finance personal, right? But just because there’s no “right” answer doesn’t mean you can’t make a prudent decision that will have a meaningful positive impact on your financial well-being. With that in mind, here’s a quick list of questions you might think about if you’re considering paying off your mortgage more quickly than scheduled…

  • How would you feel if your home were paid off? If you’re married, ask your spouse the same question (and pay attention to their answer, it’s important!) – Understanding the potential emotional benefits of being debt free can help you make a decision once you’ve calculated the other more quantitative aspects.
  • How large is your retirement portfolio relative to your payoff amount? Would paying off your mortgage leave you with too small of a nest egg to live off of in retirement? Yes, not having a mortgage payment should decrease your spending needs but what is the appropriate balance between spending and liquidity?
  • If you paid off your mortgage, what would you do with the money that was going towards your monthly payment? Would you simply spend less? Invest it? Is it possible that you’d end up spending it on things that don’t really add much value to your life?
  • Are you getting a tax deduction for the interest you’re paying on your mortgage and how much is it actually worth? How would losing that deduction impact your ability to deduct your annual giving?
  • Where would the cash come from? Is it sitting in a bank account or would you have to take it out of a retirement account and pay taxes first?
  • How would this decision fit into the context of your other financial choices? Do you always choose the least risky option? The most aggressive? It’s possible that being too conservative could make it challenging to keep up with inflation. However, leaning too often in the other direction could leave you exposed to other risks. A good financial advisor can help give you outside perspective on this. I plan to write more on this in the next few weeks.

Lastly, how would you invest the money if you decided not to pay off your mortgage? This gets to the heart of the question in my opening paragraph and, for some, it’s the deciding factor in their mortgage repayment decision. We’ve all heard that it’s better to invest money in the stock and bond markets than it is to pay down a relatively low rate mortgage, especially when the interest you’re paying is tax deductible. Why pay off a 2% mortgage when you could invest the cash and earn 6 or 7%? I appreciate that theory and I firmly believe that a smart, well-diversified portfolio will offer returns superior to the interest rate on a mortgage at today’s rates over the long haul. That’s why the financial answer for the young couple I mentioned is that they would likely be better off investing their extra cash than paying more towards their mortgage.

But what if your time horizon is shorter? The question above is based on a $400,000, 15-year mortgage at 2%. I assumed it’s in its 8th year so it has a balance of $200k. You could use your $200k to pay off the mortgage and save yourself a guaranteed $14,274 in interest. Or you could invest the money in your portfolio and continue to make mortgage payments over the next 7 years. If your portfolio earned 6% a year, you’d end up earning $101,799. The $101k sounds a lot more exciting but over 5 or 7 years your return is a bit more uncertain. The current historic bull market and lofty stock market valuations don’t help. That doesn’t mean you shouldn’t invest the cash but it’s important that you enter into your decision knowing the risks and with a clear understanding of your expectations.

Also, keep in mind that often this doesn’t have to be an all or none decision. You might choose to do what Crystal and I have done. We have a low interest rate, 30-year mortgage that’s scheduled to end when I’m 73. But rather than adhere to that schedule we calculated how much extra we need to pay each month so our mortgage will be paid off when I’m 64. I don’t think I want to retire then but that’s our financial freedom date. We invest any additional cash we have available.

In reality, it’s likely that what seems prudent to one person may make less sense to another. Still trying to decide what to do? Here are some of the pros and cons associated with paying off your mortgage.

Pros
  • Eliminates your monthly mortgage payment, freeing up cash flow that can be useful, especially during retirement.
  • Saves you money on interest.
  • You get a guaranteed rate of return equal to the interest rate on your mortgage.
  • It offers you peace of mind knowing that you own your home outright.

Cons

  • Less liquidity. More of your net worth is in your home. That may be ok if you have a decent sized portfolio.
  • You may lose the tax deduction for the interest you’re paying.
  • You could miss out on the potential for higher returns from other investments.
  • You might not realize as much from your home as you had hoped if the market drops and you have to sell quickly.

So, should you pay off your mortgage early? The answer depends on a lot of different factors. Please let us know if you’d like to have a conversation about your unique set of circumstances. We’d be happy to help.

 

 

Geoff Hall
[email protected]

My wife, Crystal, and I have been married for eight years and have two kids, Cooper (7) and Rhodes (5.) When I’m not spending time with them you might find me downtown serving at our church, pushing my limits during a mountain bike ride or having coffee with a friend in the Five Points area. I've been practicing wealth management for 25 years and I'm thankful for the privilege of shepherding my family of clients through the ups and down of the markets and of life for that matter.