If you’re thinking about paying off your mortgage, you’re in an enviable position. That’s assuming you are maxing out your retirement savings, have set aside an emergency fund and have found yourself with a sizable chunk of cash available to put toward that home loan debt.
Or perhaps you’re considering an accelerated payment plan to knock out that mortgage faster.
There are many reasons you might want to pay off your mortgage, but should you? Let’s consider whether an early mortgage payoff would be right for you.
Early mortgage payoff vs. keeping the mortgage
|With regard to||Paying your mortgage off early||Keeping the mortgage|
|Debt||Less debt increases your monthly cash flow.||If you financed — or refinanced — in the past five years or so, you have a low mortgage rate. In other words, you borrowed historically cheap money.|
|Investing||By eliminating interest payments, you gain, in effect, an equivalent risk-free return. That 4% you used to pay to the lender is now 4% back in your pocket.||Investing the money — rather than paying off your mortgage — may give you a higher return, especially in tax-advantaged or tax-free accounts.|
|Cash flow||Because your living overhead is lower, you’ll be able to tap fewer of your retirement assets to meet monthly expenses.||A long-term fixed-rate mortgage is an inflation hedge, with the risk of inflation assumed entirely by the lender. As the cost of living rises, your interest rate stays the same. Over time, the lender receives payments that are less valuable, due to inflation.|
|Taxes||You lose the mortgage interest deduction, but it’s only worth the amount that you take over and above the standard deduction, which every taxpayer gets.||You keep the mortgage interest deduction, which (slightly) reduces the effective interest rate you pay.|
|Liquidity||You can always tap the value in your home by selling it — or with a cash-out refinance, HELOC or reverse mortgage.||Paying off the mortgage puts value in an illiquid asset — meaning you can’t withdraw it from an account or spend it like cash. Borrowing against it puts you right back where you were: in debt.|
Mortgage payoff considerations
Ask financial advisors if you should pay off your mortgage early, and they’ll almost certainly say, “It depends.” That’s because everyone’s circumstances, risk appetite and debt tolerance are different. Here’s a look at different factors that might go into your decision.
If you itemize, the benefits of the mortgage interest deduction would disappear after you get rid of a home loan.
“You never want the ‘tax tail’ to wag the dog,” says Mitchell Byrum, a certified financial planner in San Antonio, Texas. “You don’t want to make decisions just considering the tax consequences, but it’s something to keep in mind.”
Your retirement planning
If you aren’t fully funding your retirement accounts, then you shouldn’t be considering an early mortgage payoff, says James Kinney, a certified financial planner in Bridgewater, New Jersey.
“The younger a person is, the more aggressively they are likely to invest. This weighs strongly in favor of investing rather than paying off the mortgage,” Kinney says. “As a person gets closer to retirement, they begin to invest more conservatively, so paying the mortgage off becomes a more attractive option.”
Kinney believes “there is also a strong emotional attraction” for retirees to enter their life after work without the burden of a monthly mortgage payment.
Don St. Clair, a certified financial planner in Roseville, California, agrees that it’s more important to tackle saving for retirement before pouring money into your house.
As for the cash flow that’s freed up by paying off the mortgage, he cautions, “All that’s going to happen is that it’s going to make its way into your lifestyle and you are going to have a bigger cliff to fall off when you actually do want to retire.”
Your interest rate
Saying goodbye to your mortgage can feel like a major financial accomplishment.
But depending on your situation, says Doug Flynn, a CFP based in Garden City, New York, it’s possible to get just as much satisfaction knowing that you have enough money tucked away to pay off your mortgage, without officially conducting the transaction.
“Oftentimes, you will hear about good debt and bad debt,” he says. “A mortgage typically falls into the good debt scenario. That’s because it is generally low interest. When you have a rate that is very low and you have the opportunity to earn more, you don’t have to be in such a rush to pay it down.”
Preparing for financial setbacks
Having a house without a mortgage can be a good thing, says Chris Chen, a certified financial planner in Waltham, Massachusetts.
“Having a lesser debt burden reduces your break-even for life expenses, such that the impact of a layoff or other adverse financial event will be less painful,” he says.
However, paying off the mortgage is like investing in an illiquid asset. “You can’t easily tap the funds,” Kinney says. “It is important you have emergency funds available in an easily accessible account before applying funds to mortgage pay-down.”
One option is to establish a home equity line of credit as a “just in case” financial resource.