Pros and cons of paying off your mortgage
It might be emotionally appealing to pay off your mortgage. Financially, it may not be a good move. Find out why.
It may be tempting to pay off your mortgage early if you're in a position to do so. But in some cases, you may not be better off.
Mortgage rates are at historic lows.
First, remember that mortgages today don't cost much. Interest rates on all but the largest mortgages are lower than 4 percent. (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 percent tax bracket and your mortgage charges 4 percent interest, your effective after-tax rate is only 3 percent.
Investing and saving
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 instead you invest the money you would've used to pay off your mortgage into a retirement account, your return over the long term may exceed savings of paying down your mortgage.
Over the long term, your money may work harder for you in a diversified portfolio of stocks and bonds than if you use it to pay down your home loan.* 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.
Of course, if your emergency fund is low or if you're paying off credit card debt with high interest rates, put the money there instead. "Get out of the credit card circle of death," says Stephen Popper, a financial professional in Sage View Advisors' Boston office.
Paying it off
In some cases, paying off your mortgage might make sense.
- If you're retiring in the next five years, and you're able to completely eliminate your mortgage, then consider doing so. That should substantially improve your cash flow picture once you retire. If you no longer have to pay your mortgage, you should be able to decrease the amount you withdraw each year from your retirement accounts.
- 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 $417,000 — you may be able to reduce your interest rate by half a point or more.
- If you have a high interest rate 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.
Speak with a financial professional to compare both scenarios — one where you keep your mortgage and another where you use your retirement savings to pay off the mortgage.
*No investment strategy can guarantee a profit or protect against loss in periods of declining values.
Stephen Popper, and Sage View Advisors are not affiliated with the Principal Financial Group or any of its member companies.
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