Mortgage Debt has a Purpose
Debt allows most people to make a large purchase normally out of reach and pay for it over a period of time with interest. A mortgage makes home ownership affordable because you establish a loan to pay for the home over the course of 15-30 years.
Between mortgage payments, real estate taxes, and maintenance costs, your home may be your biggest monthly expense. A benefit of paying down your mortgage is an increase in equity. Equity is something that had you been renting you would not be achieving. Equity is the value of your home you keep in dollars if you sell it later.
An often asked question is whether the mortgage should be paid off early using funds from another source. While having a mortgage fully paid off may feel great, there are times when even if you have the cash to pay off your mortgage, it may make sense to keep making monthly payments.
Sometimes it is a financial mistake to pay off the mortgage on your primary residence. Other times, it makes perfect sense. Allow me explain.
Don’t Pay Off Your Mortgage When...
There are seven reasons it may not make financial sense to pay off your mortgage early.
Interest rates are lower than you can earn in other investments.
You haven’t fully funded your 401k, IRA, and other retirement savings.
You need to withdraw money from your retirement savings to pay off your mortgage.
You plan to sell highly appreciated stocks and incur a large tax bill to pay off the mortgage.
You have consumer debt with higher interest rates than your mortgage.
Doing so would concentrate the majority of your wealth in your primary residence.
Your mortgage schedule will pay off near your retirement date without extra payments.
It may be worth continuing to have mortgage payments when your budget is balanced. This is where you are saving enough for retirement each year and you can easily make your mortgage payment without budget stress. This provides an opportunity to invest the excess money that would’ve gone to your mortgage and earn a greater return in the stock market than the interest payment.
Remember there are alternatives to paying off your mortgage in one fell swoop.
If you’d like to make an impact on your mortgage without contributing the bulk of a sudden windfall, consider one of the following:
Refinance your mortgage loan. Take advantage of mortgage rates being at an all time low. Contact a mortgage loan officer to obtain a quote and see if you qualify for a lower interest rate. It shouldn’t cost you anything unless you accept the refinance offer.
Add an extra principal payment. Contribute an extra principal payment each quarter or monthly to eliminate your mortgage right before you retire. Make sure to include a note on your extra payments that you want the funds applied to the principal balance as the mortgage company’s default is to apply surplus funds towards the following month’s payment.
When It Might Make Sense To Pay Off Your Mortgage:
These are six reasons where it may make financial sense to pay off your mortgage early.
You own a business that generates sufficient income for you to live comfortably in retirement.
You have enough invested for retirement in 401k, IRA, and brokerage accounts to pay for living expenses as well as unexpected medical costs and long term care if needed.
You and your spouse want the creditor protection of a tenant in the entirety holding where your fully paid off home is remote from creditor claims in the event of a lawsuit.
The interest rate on your mortgage is higher than you can earn elsewhere.
The burden of your monthly mortgage payment would hurt your lifestyle in retirement.
You will still have sufficient emergency savings equal to six months or more salary even after paying off the loan.
If paying off your mortgage early will not hurt your current lifestyle or the retirement income projections generated by your financial advisor, then by all means go ahead and pay it off. Once you pay your home off, you can consider a home equity line of credit if you ever need liquidity in the future.
As a financial advisor whose clients have mortgages ranging from $100k to $2.5 million or more on their primary residence, this is a question that comes up at least once a year. There is no one-size-fits-all solution.
The decision to pay off your mortgage note earlier than the agreed schedule needs to be based upon your unique finances and important details.
My recommendation is to consider the interest rate on your mortgage, when the mortgage loan will naturally be paid off without extra payments, where the funds will come from if you are looking to pay it off early, and whether you are getting a tax benefit for your interest payments.
If you require assistance to review the details of how your mortgage debt fits in with your overall financial plan, schedule a call with Peter to learn how he can identify your goals and vision.
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About the Author
Peter Newman is the president of Peak Wealth Planning. He offers financial planning, investment management, retirement income, insurance and estate planning advice. Peak Wealth is a fee only financial advisor based in Champaign, Illinois.