My friend Amy recently wrote with an interesting dilemma. “Should I pay off my mortgage early?” she wonders.<\/p>\n
Amy has a high-paying job and has managed to save enough that she could be completely debt-free if she wanted to. And she kind of wants to! But is this the best choice? She’s aware that this is a nice problem to have \u2014 but it’s still a bit of a muddle. She’d like some guidance.<\/p>\n
Here’s an abridged version of her email:<\/p>\n
I’m wondering if you have any advice for me related to paying off a mortgage vs. keeping it for tax purposes.<\/p>\n
Here\u2019s the basic rundown: I have 22 years and $103,000 left on a 30-year fixed-rate mortgage at 3.95%. My monthly payment is $668 per month.<\/strong> I will pay about $48000 in interest this year. I pay both my taxes and insurance out of pocket annually.<\/p>\n
The past two years, I’ve made close to a quarter of a million dollars each year, and this year I will likely exceed that amount. This is a wonderful place to be. With no other debt, I’m contemplating whether I should completely pay off my mortgage in one swoop come November when I get my bonus.<\/p>\n
I have advice coming from both sides. My accountant warns me against it, as I would have no other write-offs to offset my high income. However the freedom of being DEBT FREE sounds amazing, even if it comes with a high tax bill.<\/p>\n
I would love your advice (or the advice of your readers, if this offers an opportunity to share with them).<\/p><\/blockquote>\n
My stock answer to this question — which I get a lot — has always been: This is a no-lose situation.<\/strong> Deciding whether you should pay off your house is a case where either option is awesome.<\/p>\n
Mathematically (and financially), the best choice is almost always to carry the mortgage. However<\/em>, many people receive a huge psychological boost from not having a mortgage. In other words, this is one of those situations where the smart financial decision and the smart psychological decision aren’t necessarily the same.<\/p>\n
Although Amy is asking specifically about the tax implications, let’s start by examining the Big Picture.<\/p>\n
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<\/span>The Pros and Cons to Paying Off Your Mortgage<\/span><\/h2>\n
Just so everyone is on the same page, here’s a quick look at the pros and cons to paying off your mortgage. There are advantages and disadvantages to both choices. Are certain advantages more important than others? You make the call. <\/p>\n
Here’s why you might want to pay off your mortgage early:<\/strong><\/p>\n
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- Whenever you pay off debt \u2014 including your mortgage \u2014 you earn a guaranteed return on your money. The stock market returns<\/a> a long-term average of 6.8% (real returns), but average is not<\/em> normal<\/a>. There’s a lot of risk involved investing in the stock market. If you’re not comfortable with that risk, paying off your mortgage is a fine investment. More on this in a moment.<\/li>\n
- I like to think of home equity as a “store of value”. When you pay down your mortgage, it’s like putting money in the bank (albeit money that’s harder to access). That equity can be tapped when needed. In the meantime, it slowly appreciates (assuming the value of your home increases).<\/li>\n
- If you’re currently paying private mortgage insurance<\/a> \u2014 typically in cases where you have less than 20% equity in your home \u2014 then paying down your mortgage will help you eliminate that cost. This isn’t applicable to Amy’s situation, but it’s something others might want to consider.<\/li>\n
- There’s absolutely a sense of relief that comes from being mortgage-free. You know that if things go to hell \u2014 you lose your job, the economy tanks, et cetera<\/em> \u2014 at least you have a place to live.<\/li>\n<\/ul>\n
On the other hand, there are reasons you might want to keep a mortgage for as long as possible. Here are some reasons you might decide you’d rather not<\/em> pay off your mortgage:<\/strong><\/p>\n
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- If you believe you can earn a higher rate of return investing elsewhere, then that’s the most sensible choice. In our recent era of low mortgage rates and high stock market returns, for instance, the logical choice was to invest in the stock market instead. In the 1970s, though, when mortgage rates were high and the stock market was lethargic, this wouldn’t have been a smart decision. (Here’s a simple calculator<\/a> that can help you weigh this decision.)<\/li>\n
- Some folks — like Amy’s accountant, apparently — believe that the tax breaks from your mortgage make it worth keeping. The home mortgage interest deduction, they say, helps to lower your obligation at tax time. While this is technically true, it’s a poor trade. (You’ll see why in the next section.) Still, as part of the Big Picture, it’s an influencing factor.<\/li>\n
- Although it’s not often a consideration, inflation is actually your friend when it comes to a mortgage — especially a 30-year mortgage. I bought my first home for $108,000 in 1993. If I had kept that home and mortgage, I’d still be paying on it until 2023. But I’d be paying with current<\/em> dollars, which are only worth about 57 cents<\/a> compared to 25 years ago. Inflation is generally the enemy; with a mortgage, it’s your friend.<\/li>\n
- Finally, it can make more sense to keep your mortgage if you value liquidity. That is, if you want and\/or need cash, keeping the mortgage can be the better option. Once you give your mortgage company your money, it’s a pain to get it back.<\/li>\n<\/ul>\n
Because of my own situation, I feel like that last point deserves a closer look.<\/p>\n
You see, I’ve been without a regular income for more than five years now. I’m living off my savings. It’s true that I have substantial savings (for which I’m grateful), but much of it is held in retirement accounts that cannot be tapped without penalty until I turn 59-1\/2. (That’s less than ten years away now!)<\/p>\n
I have a roughly $300,000 nest egg to last me the next ten years. If the stock market falls, that number will shrink. There’s a part of me that wishes I hadn’t been required to pay $442,000 cash for this house last year. It’d make me feel better to have some of that equity \u2014 maybe half of it? \u2014 in the stock market and savings accounts<\/a> instead.<\/p>\n
As it is, I could be in a pickle if it turns out I need more cash.<\/p>\n