Key Takeaways
Know the three biggest drawbacks to paying off your mortgage early.
Don’t overlook your time horizon, current market conditions and other avenues for deploying your wealth.
With so many emotional, psychological and financial factors at play, a trusted advisor can be a huge help.
For many people, the mortgage on their primary residence is their single biggest debt. One of the first things many clients ask us as they get closer to retirement is whether they should pay off their mortgage. Most people don’t want to go into retirement with loans hanging over their heads. It can be tremendously satisfying to say you finally have the house “paid off” and no longer have to make monthly mortgage payments. It’s also rewarding to see all the home equity built up in your net worth statement. However, purely from a financial perspective, it is often better to keep your mortgage in place, especially if you locked in a very low interest rate.
When it comes to the decision to pay off your mortgage, there are many emotional and psychological considerations, not just financial ones, at play. It can be very helpful to have an advisor to guide you through the decision-making process since you are making a financially advantageous decision and not one based on emotion. Let’s take a closer look at the pros and cons of paying off your mortgage early.
Advantages Of Paying Off Your Mortgage Early
The biggest benefit to paying off your mortgage early is gaining peace of mind. Few other financial goals give you the same sense of accomplishment and freedom than owning your home outright. For some clients, knowing that no one (including the bank) can take away your home from you is priceless.
Many clients have the long-term goal of being 100% debt-free in retirement. Paying off your mortgage early will reduce the overall amount of interest paid over the life of the mortgage, which can amount to hundreds of thousands of dollars. Not having this monthly payment also frees up more monthly cash flow for other goals, such as big-ticket purchases, travel, and charitable giving.
Drawbacks To Paying Off Your Mortgage Early
One of the most overlooked drawbacks is not putting inflation to work for you. I know that sounds counterintuitive, but when you have debt, inflation erodes the value of that liability over time. For example, a $6,000 monthly mortgage payment in 2024 might seem high, but if you have a fixed-rate mortgage, that’s a stagnant number. After 10 or 20 years, $6,000 becomes a much smaller number after adjusting for inflation. This is especially true as your income and/or portfolio value increases over time. For example, milk is about $4 per gallon today. I know that sounds high to many people, but imagine if milk stayed at $4 per gallon by 2034 or 2044? It would seem relatively cheap by then. The same goes for your mortgage.
Another drawback to paying off your mortgage early – especially if you locked in a low rate of 3.5% of less -- is the missed opportunity of not being able to deploy that money into a different investment with a higher return. If a penny saved is a penny earned, then paying off mortgage debt at 3% is the same thing as investing the money at 3%. Ultra-safe Treasury Bills are paying higher interest than 3% today. If you have cash available to invest, what is the best use of your money?. Borrowing at a low rate and reinvesting at a higher one is called arbitrage. This technique helps our clients grow their wealth in a tax-efficient manner.
Another drawback to paying off your mortgage early is not being able to spread out the cost of that obligation over time. If your savings are primarily in a pre-tax account like a traditional IRA, then being able to spread out payments over time is beneficial since your income tax rate will be lower. It’s not a good idea to take a lump sum distribution from your IRA, pay income tax on it, and then pay down your mortgage when on the other hand, you can keep the mortgage, spread out your distributions from your traditional IRA over time and keep your effective tax rate low. This strategy is more beneficial as you build up more pre-tax assets such as IRAs and other income producing sources such as Social Security, pensions, annuity income, and part-time work. The tax impact from these sources of retirement income can be reduced if you retain a mortgage and receive the interest deduction on your tax return.
Time Horizon
In addition to the pros and cons listed above, I always advise our clients to consider how long they plan to remain in the house before debating whether to pay off the mortgage. It doesn’t make sense to pay off your mortgage early if you’re not planning to live there for many more years. Why tie up your cash when you can simply use the proceeds from selling your house in a few years to pay off the outstanding balance on the mortgage? Why give up the flexibility?
Conclusion
When it comes to paying off your mortgage, there is no single best approach for everyone. That's why it's a good idea to have an advisor to talk through the pros and cons. If paying off your mortgage is a lifelong goal and it gives you peace of mind, then it might be a good idea for you. However, if the success of your financial plan requires you to maximize your wealth, then you’ll be better off financially by continuing to hold a fixed rate mortgage. The best approach takes into account your time horizon, current market conditions, individual financial goals, and risk tolerance. That is why working with an advisor such as Novi helps. We can offer an expert financial perspective and help you maximize your wealth.
RYAN M. VOGEL, CFP® is the CHIEF PLANNING OFFICER, PARTNER at Novi Wealth
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