Should You Pay Off The Mortgage?

Debt, Retirement, Technical Analysis

I’m frequently asked about paying off a home mortgage. I tell everyone, “It depends!”.

I asked that same question. A friend said his CPA was emphatic that one should not pay off their mortgage. He arranged a meeting where the three of us could talk.

The CPA asked about the interest rate; 6% at the time. He showed me excellent stock market returns, suggesting I could earn more than 6% and continue deducting interest on my tax return. Other People’s Money (OPM) was the buzzword at the time. The smart people used borrowed money to become wealthy.

I was self-employed and worried if I had a bad month. Wouldn’t not having a house payment be a good thing? He said, “NO! Financially it’s not a smart move.”

“Is your home paid for?”, I asked. His response, “Oh Hell Yes!” I was shocked. He explained his wife was from Europe. They don’t believe in debt – she made me pay it off. I asked, “Do you sleep better at night not having to worry about a house payment?” With a sheepish grin, he replied, “Yeah, I do.”

I realized the decision is both emotional and financial and the right decision is different for everyone. I upped my house payment and in a few short years, it was paid off. I never looked back!

Please don’t jump to any conclusions – there are other factors to consider.

What’s the real goal?

The goal is to eliminate ALL DEBT and accumulate wealth; particularly retirement funds. Paying off a home mortgage is one step in the process.

Not everyone agrees.

In the MarketWatch article, “Should you pay off your mortgage or invest the money?” they outline 5 reasons to keep your mortgage.

  • Homeowners need to maintain liquidity.
  • A mortgage doesn’t affect a home’s value.
  • Mortgage interest is inexpensive.
  • Mortgage payments get easier with time.
  • Investments will outperform the interest cost of the mortgage over the long term.

Let’s dissect the premise using (fictitious) Bob & Mary Jones. Their combined income is $80,000. They have a $200,000, 30-year conventional mortgage at an interest rate of 4.5%. Bankrate.com provides a handy Amortization Schedule Calculator. Their monthly payment would be $1,013.37.

Money Under 30 provides a tool, “How Much House Can You Afford?”They tell us:

“…. The golden rule in determining how much home you can afford is that your monthly mortgage payment should not exceed 28 percent of your gross monthly income. For example, if you and your spouse have a combined annual income of $80,000, your (monthly) mortgage payment should not exceed $1,866.”

Bob & Mary are well within the guidelines.

Homeowners need to maintain liquidity. You need enough liquid assets on hand to cover an unexpected emergency or job loss.

If they felt comfortable with a six-months income available ($40,000) they have several options. Pay down (but not pay off) the mortgage and hold back their savings. By doing that, a larger percentage of their house payment goes toward principal, providing significant interest savings.

I’ve seen cases where homeowners have a “signature line of credit,” using their home as collateral. If they have an emergency, the bank will put the money in their checking account. They don’t pay interest unless there is a real emergency and they have to borrow.

A mortgage doesn’t affect a home’s value. We are concerned about increasing the net worth of the homeowner. Interest is renting other people’s money. The less you pay in rent, the more you can save and build your own net worth.

Mortgage interest is inexpensive. While interest rates may be historically low, how much money you have to pay in interest is the major issue.

The Amortization Calculator tells us Bob & Mary will pay $164,813 in interest over the life of the loan. Interest adds 82% to the cost of their home.

Nerdwallet suggests you should keep your mortgage:

“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.”

Hang on a minute here! Bankrate.com also provides a Mortgage Payoff Calculator. Each year, Bob & Mary pay $12,156. In the first year, 73% of their monthly payment went to interest. The early years of a mortgage are when you pay the most interest.

Amortization Schedule

Payment Date Payment Principal Interest Total Interest Balance
Jan 2018 $1,013.37 $263.37 $750.00 $750.00 $199,736.63
Feb 2018 $1,013.37 $264.36 $749.01 $1,499.01 $199,472.27
Mar 2018 $1,013.37 $265.35 $748.02 $2,247.03 $199,206.92
Apr 2018 $1,013.37 $266.34 $747.03 $2,994.06 $198,940.58
May 2018 $1,013.37 $267.34 $746.03 $3,740.09 $198,673.23
Jun 2018 $1,013.37 $268.35 $745.02 $4,485.11 $198,404.89
Jul 2018 $1,013.37 $269.35 $744.02 $5,229.13 $198,135.54
Aug 2018 $1,013.37 $270.36 $743.01 $5,972.14 $197,865.17
Sep 2018 $1,013.37 $271.38 $741.99 $6,714.13 $197,593.80
Oct 2018 $1,013.37 $272.39 $740.98 $7,455.11 $197,321.40
Nov 2018 $1,013.37 $273.42 $739.96 $8,195.06 $197,047.99
Dec 2018 $1,013.37 $274.44 $738.93 $8,933.99 $196,773.55

It will take over 15 years (August 2032) before ½ of their monthly payment is applied to the principal.

Mortgage payments get easier with time. That is true, unless you are getting close to retirement and realize you need to accelerate your retirement savings.

What could be easier than having NO mortgage payment and not having to worry about it?

In today’s world of job insecurity, few pundits ask, “What happens if you lose your job?” Not having a mortgage payment can make the new job search much less stressful.

Investments will outperform the interest cost of the mortgage over the long term. It may be true if you are a top-notch investor and have plenty of time to spend studying and staying on top of things.

If mortgage interest rates are low, safe, high quality fixed income investments pay even less. Can you guarantee you will not lose money?

I have friends in their early 60’s who chose not to pay off their mortgage and saw their nest egg cut in half during the last downturn. They were trying to squeeze every last dollar out of the market and got caught. Some are still working.

There is one exception. If you are self-employed you may need to borrow and invest in your own business. The risk is much better understood.

A common sense approach

Assuming the goal is to be debt-free, and accumulate wealth, start with the big picture.

List all your debts, monthly payments and interest rates. How much do you owe? How much cash (excluding retirement accounts) do you have available?

How much do you need to maintain liquidity? While you may be able to pay down your mortgage, don’t create another problem. Make sure you have ample “reserve emergency funds” available.

What to pay off first? Conventional wisdom is to first pay off the high interest loans and credit cards, or those with the most burdensome monthly payments.

Know thyself! If you fear having an impulse to “go out and buy something else,” be realistic. You might be better paying your mortgage down to temper your impulse buying.

Pay ahead of schedule. Bob & Mary might choose to use $50,000 to pay down their mortgage. That cuts their mortgage by approximately 12 years. While the payment remains the same, a much higher percentage is applied to principal.

Bob & Mary could cut five years off their loan in a couple of ways. They could increase their payment $100/month.

-or-

Bankrate.com offers a Biweekly mortgage calculator. Paying ½ every two weeks saves on interest and adds one additional payment annually.

Misinformation

Don’t get fooled by the malarkey that you should have a mortgage because the interest is deductible – chances are you won’t use it. The Tax Foundation tells us in 2013, 30% of taxpayers itemized their deductions, generally high wage earners.

Forbes outlines a White House study about the recently passed tax reform bill, “Nine In Ten Will Claim The Standard Deduction.”

When it happens….

The benefits of owning your own home are both financial and emotional. It’s hard to explain the exhilaration of paying off your home and committing to never borrow money again.

I have NEVER met anyone who paid off their mortgage that regretted it.

Paying off your mortgage is a great feeling; however, it is part of a bigger picture – being debt free! That is where true wealth accumulation begins.

The Big Kahuna

Once you are out of debt, you are not “home free” (pun intended). What do you do with the money left over each month? While it may be fun, paying cash for expensive, depreciating assets is not accumulating wealth. Focus on a higher priority first.

The most basic human need is survival. Next is security – “survival for tomorrow”. When you can no longer work, how are you going to survive? Accumulated wealth allows you to meet those needs with minimal worry.

Maximize your contributions to your 401k, IRA and any other retirement plans you may have. Then you can realistically calculate how much “fun money” you really have. You will still have fun along the way, knowing your plan is working.

Do I recommend paying off your mortgage? Absolutely! The Baby Boomer generation, in particular, is at the point where capital preservation, not taking high risks hoping for a good return, take precedence.

If you can’t pay off your mortgage today or in the near future that’s OK. Take stock of things and build a plan to get out of debt; you will be there before you know it! You will never regret paying off debts!

For more detailed information on how to get the job done, you can download my FREE report: 10 Easy Steps To The Ultimate Worry-Free Retirement Plan – by clicking HERE.

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