We’ve recently heard from a number of clients who wondered whether they should pay off their mortgages. I tell them that there are a couple of ways to answer this question. One is what I call the “MBA Final Exam” answer and the other is the “Feel-Good Test.” Before I explain the merits of each way of thinking, though, here are some reasons why the question “Should I pay off my mortgage?” is so timely.
- 1. Interest rates are starting to rise. Clients who have adjustable-rate mortgages are particularly curious about whether a mortgage payoff is a smart financial move. No one quite knows where rates might end up three or four years from now.
- Tax law changes make a mortgage a less attractive deduction. In the past, homeowners could deduct mortgage interest on the first $1.1 million of their loan. That’s now been cut to the first $500,000 on mortgage debt. Also:
- Taxpayers can now deduct on their federal return only up to a combined $10,000 in state and local taxes. That figure includes property taxes.
- The new $24,000 standard tax deduction for couples mean that people who don’t have a high mortgage balance probably won’t end up itemizing and claiming their mortgage and property taxes anyway.
The MBA Final Exam Approach
If you look at a mortgage payoff from a purely financial point of view, you’re just doing math. You compare the after-tax interest rate you’re paying on your mortgage to the after-tax return you’re earning on your overall portfolio.
If your money is projected to earn more (return is higher) in your portfolio, you keep it there and don’t pay off the mortgage. However, if your portfolio earnings are likely lower than your mortgage rate, you go ahead and pay off the mortgage.
The Feel-Good Test
The second way to approach a mortgage payoff is the “gut” question: Would you feel better knowing that you have a paid-off mortgage? For some people, there’s no greater joy than being completely debt free. This may be especially true for folks who are close to retirement.
If this is the case, I tell clients to go ahead and pay off their house. We spend money on all kinds of things to make us feel good. Paying off your mortgage is a pretty tame indulgence.
Plus, paying off your mortgage lowers your overall financial risk level. The return on your portfolio is not a sure thing—it could go up or down. But when you pay off your mortgage early, you are guaranteed to save all of that future loan interest.
What About Using Cash to Pay Off My Mortgage?
Maybe the money you would use to pay off your mortgage isn’t invested in your portfolio. It’s sitting in cash, earning less than 1% in a savings account. In that case, would you be better off using that money to pay off your 4% mortgage instead?
Posed as” cash vs. mortgage,” the issue becomes a very interesting behavioral finance question.
If you take the MBA final exam approach to cash vs. mortgage, you have to admit that cash is money that’s not being used to its full advantage. It’s sort of in a comfortable savings account waiting room. As a result, the savings rate vs. portfolio rate is not a fair mathematical comparison.
The real question is this: Should I use my cash to pay off my house or should I invest it in my portfolio? When you look at the question that way, you’re back to the same math equation from the MBA final exam approach: Which interest rate is higher—portfolio or mortgage?
What about looking at cash vs. mortgage through the feel-good test lens? Again, this question isn’t posed quite accurately. You’re really asking: Do I feel more comfortable using my cash to pay off my mortgage or using it to build my portfolio? There’s no wrong answer here. If you sleep better at night with no mortgage over your head, pay it off. If you’d rather grow your portfolio, invest the money instead.
Are You Undecided About Your Mortgage?
Give us a call. Your RegentAtlantic Wealth Advisor can help you sort out your options and priorities.
And don’t worry: We aren’t here to push you into a set decision. RegentAtlantic’s mission is to partner for financial well-being. Even though I’m an MBA investing nerd myself, I appreciate the sense of financial well-being that being debt free can bring and usually recommend paying off the mortgage.
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