Approaching retirement with a mortgage fully paid off can translate to increased discretionary income from fixed sources when you retire. While there are instances where the savings from paying off your mortgage prematurely may not surpass potential earnings from alternative investments, the non-monetary advantages, such as peace of mind, associated with early mortgage repayment may outweigh the financial considerations.
If you are like most Americans who own a home, you probably have a mortgage. As the years go by, you may wonder if it is worth it to pay off your mortgage ahead of schedule. This may be a possibility for some homeowners who come into a lot of money through an inheritance or other means.
Are There Financial Benefits to Keep a Mortgage When You Retire?
As many financial advisers will tell you, there are advantages and disadvantages with paying off your mortgage early. There also are psychological factors that could make it a good or bad choice to pay off your home mortgage depending upon you.
Paying off your mortgage ahead of schedule is an effective method to enhance monthly cash flow and reduce interest payments. However, this approach involves forfeiting the mortgage interest tax deduction, and it may be more lucrative to invest the funds instead. Prior to reaching a decision, evaluate how you intend to utilize the additional funds each month.
Clearing your mortgage ahead of schedule is generally a wise choice, but there are instances where directing your funds elsewhere may be more advantageous. This is especially true if you have pressing, unfulfilled financial priorities, such as bridging gaps in retirement savings or addressing burdensome debt.
At times, it might be prudent to postpone those early or additional payments. Accelerating the repayment of your mortgage involves allocating additional funds each month to diminish the outstanding balance. It’s essential to bear in mind that your agreement with the bank is binding, with fixed principal and, unless subject to a variable interest rate, unalterable payments. This stability provides a known and budgeable expense.
What the Math Says About Paying Off Your Mortgage Early
There are some financial experts that only look at the financial aspects of paying off your mortgage loan. These people will often say that you should not pay down or pay off your mortgage if you have a long term, locked low interest rate. For example, if you got a home loan in 2015 or 2016, you may be locked into a 30 year, fixed rate below 4%. Good luck finding that in 2023 or 2024! These days, you see rates at 6% or even higher. We anticipate mortgage rates will fall again next year, but there are no promises.
These experts say you would be better off investing money in the markets where a diversified stock portfolio would pay you 7% or so over the long term.
This thinking says that you should not pay down a mortgage that is at 4% or lower when you can earn more return with stocks. If you add in the home mortgage interest deduction, you can see how it might not make economic sense to pay off the loan early and miss the tax advantages on top of the low rate.
But the Emotional Component
Still, there are a lot of home owners who understand it might not make complete financial sense to pay off the mortgage but do it anyway. Some people do not care as much about the tax advantages or even giving up a low interest rate. For these types of people, the decision to pay off a mortgage is about emotions and a feeling a freedom and less about financial advantages of disadvantages. There are just a lot of people that do not like to be indebted to a bank.
Looking at the Pro’s and Con’s of Paying Off Your Mortgage Early
As noted above, the mortgage interest deduction is the one that many homeowners like. The easiest way to determine how this helps your tax situation is to look at whatever your effective tax rate is. If you have a tax rate of 22%, your home mortgage interest deduction will reduce your federal income taxes by $22 for every $100 you are paying in mortgage interest.
That is a nice tax advantage, but there are some caveats. Your home interest deduction is only for the amount that you deduct above your standard deduction, which is what taxpayers get who do not itemize.
As of this year, the standard deduction has increased to $24,000 for a married couple and $12,000 for individuals. Also, the new Trump tax law put a $750,000 cap on your mortgage interest deduction. This means that you can only deduct interest on a home loan below this amount.
This means that the higher standard deduction will have fewer of us itemizing their taxes. If you do not itemize, your home mortgage interest deduction is of no value. Even if you do itemize, it is only worth what it is going to save you over your standard deduction. For many Americans, the value of the mortgage interest deduction has been greatly reduced, so it is less of a reason to hold off paying off the mortgage.
If you take the money you would use to pay off the mortgage and invest in the stock market, there is no guarantee you will make the rate of return you want. On the other hand, paying off the mortgage is a sure thing.
For many Americans, a balanced approach is best. Instead of paying off the entire mortgage, consider throwing a few thousand extra dollars at the debt each year, and maximize your retirement accounts. Paying off your home early can be a good move, but many would say it is best only if you have been investing heavily all along and have met other financial goals first.
While paying off your 1st or 2nd-mortgage early is generally advisable, there are situations where deploying your funds elsewhere may prove more advantageous. This is especially pertinent if you have pressing financial priorities, such as catching up on retirement savings or addressing burdensome debt. Additionally, it might be the case if you identify an evident arbitrage opportunity, highlighting a disjunction between the expected returns from the stock market and the interest rate on your mortgage.