Invest or Pay Off Your Mortgage?
About the author: Jeff Martin is a financial advisor at Cornerstone based in Reno, NV. Jeff has earned the Life and Health Insurance Licensure and has passed the Series 65 examination. He enjoys being able to help clients create customized strategies for their portfolios based on their unique financial goals.
Invest or pay off your mortgage?
The question, “Should I pay off my mortgage?” comes up regularly. Given that a mortgage is generally one’s largest debt, the question certainly should arise on how to best manage it. I will preface that the old misnomer of “in order to retire, you need to go into it without a mortgage” isn’t always true.
I have shared and discussed in previous writings some of the frustrations (and alternatives) for a low interest rate environment, like the one we are currently familiar with. As in many situations, there are usually pros and cons. The con, well, I’m sure you have already noticed, the lack of interest being earned on your savings account at your bank. The pro is that this period of time will likely be the cheapest mortgage environment that we could find ourselves in. This means you are most likely paying substantially less in interest to the bank than you would in a higher interest rate environment (which is where we would expect the market is heading).
Given that we are in an incredibly low interest rate environment, and paying less for mortgages, in some cases it makes more sense to maintain a mortgage than the latter. For example, say someone has a fixed 30 year, $500,000 mortgage at 3.75%. Assume their monthly mortgage is easily managed within their monthly cash flow (this is paramount), and they do not anticipate any changes in their income in the foreseeable future. They could use $500,000 of their reserve assets to pay off the mortgage and reduce their monthly expenses.
What transpired here is now this person(s) reserve assets have been reduced by half a million dollars. This could potentially be an undesirable outcome in situations where something unexpected arose, for example unforeseen medical expenses, and due to the payoff, there are now insufficient assets to handle it. Sure, you would have equity in the home to potentially use, or you could maybe even consider a reverse mortgage, but where will the housing market be at that time? Taxes are also a very important piece to consider here. Are the assets being used to pay off the mortgage coming from an IRA? How would an additional $500,000 of taxable income in that year affect your tax return? Not favorably.
Given that the mortgage is now paid off, and these individuals’ income remained consistent as planned, they could begin saving that monthly amount to build up the reserves once again. You can suspect it would take an exorbitant amount of time to recoup those assets.
A key point to consider is the interest rate on the mortgage. In this case, 3.75%. The question should be asked: Can I earn at least or more than that on my assets if they were invested? If so, that 500k is better positioned for long term growth, as you would expect to earn more than the 3.75% over a period of time.
Let’s now work through where paying off a mortgage can make more sense. One, if you have a high interest rate, or variable rate, and are unable to refinance, the discussion should be had. Second, in order to maintain your financial security, your expenses need to be reduced, and a true analysis indicates you are better off using reserve assets and reducing expenses. Third, you are no longer receiving any tax benefits for maintaining the mortgage (which many don’t after the 2018 tax reform). Lastly, you simply feel and sleep better knowing the mortgage is paid off, and regardless of the craziness that might ensue in the world, you will always have a roof (that you own) over your head. This last one should not be discounted in any way.
As with many of these topics, each situation can be quite unique, and what can make sense in one situation, has no business being in another. With this being the case, if it is a concern, or perhaps some curiosity has been peaked, I would encourage you to discuss it with your financial advisor to determine what makes the most sense for your situation.