Managing Your Mortgage: To Pay Off or Not To Pay Off?
When it comes to financial priorities, paying off your mortgage should be first on the list. Right? Not necessarily.
Why you should wait to pay off your mortgage
Mortgage rates are at historic lows.
First, remember that mortgages today don't cost much. Interest rates on all but the largest mortgages are around 4%. (If you pay a significantly higher rate, consider refinancing.)
What's more, the interest you pay on your mortgage is generally tax-deductible, making the effective rate even lower. If you're in the 25% tax bracket and your mortgage charges 4% interest, for example, your effective after-tax rate is only 3%.
Investing can be a smarter move.
Whether or not you should pay off a mortgage depends on how close to retirement you are and what the rest of your financial picture looks like.
If you invest the money you would've used to pay off your mortgage into a retirement account instead, your return over the long term may exceed the savings of paying down your mortgage.
Even if you're nearing retirement, contributing to your retirement account may still make sense, as your retirement savings may need to last for 20 years or more.
And if your emergency fund is low, or if you're paying off credit card debt with high interest rates, put the money there instead. Your first priority should be to "get out of the credit card circle of death," says Stephen Popper, a financial professional in Sage View Advisors' Boston office.
So when is paying off your mortgage the right move?
If you're retiring in the next 5 years, and you're able to completely eliminate your mortgage, then consider doing so. It will substantially improve your cash flow and decrease your withdrawal requirements in retirement.
Or, if your original mortgage was large, and you can pay off enough of the principal to qualify for a so-called "conforming" loan—typically one less than $424,100—you may be able to reduce your interest rate by half a point or more.
Finally, if you have a high interest rate on your mortgage and are unable to refinance—for example, if you owe more than the house is worth—it may be prudent to focus on paying off your mortgage.