If you are closing in on your retirement date, this question is likely one you've been thinking about. There are two perspectives from which to look at this dilemma:
Perspective #1: Emotionally, it may feel better to pay if off. This is a tough argument to combat as you may get a sense of relief to head into the sunset with no debt on the books. There's much less stress on your monthly cash flow and "debt" is a bad word, or so our parents and grandparents have preached to us.
Perspective #2: Financially, it may not make sense to pay it off. Let me explain. Let's assume you are in a moderate income tax bracket – say 35% combined federal and state tax. Let's also assume your current mortgage rate is 4%, which means after deducting the mortgage interest as an Itemized Deduction, you are actually paying about 2.60%.
• Just because your mortgage is paid off, doesn't mean your home will appreciate in value any faster--so no advantage on this front.
• By paying off the remaining mortgage balance, you are in essence saying that you cannot beat a 2.60% annual return (over time) with any other financial instrument. In other words, you would be pulling dollars out of a balanced, globally diversified portfolio earning 6% to 8% over the long-term, to pay off a 2.60% after-tax debt. Instead, what I am suggesting you do is what all banks do – borrow from their clients (via their checking & savings accounts) at zero to 0.05%/year and lend those dollars to their customers at 3% to 5% / year and earn the spread.
• Here's a question for you: What rate of return does the bank pay you on the dollars you've just handed over to pay off your mortgage? The answer is zero. In other words, once those dollars are in the hands of the bank, you earn nothing on them.
• Say you do pay off your mortgage and eventually need to access your home equity at some point in the future (job loss, illness / health issue, family emergency, etc.). How do you get at your home equity? The answer is you refinance your mortgage and pay refinancing costs to get at your own equity / money.
- So, not only does the bank pay you a zero percent return on the dollars you handed over to pay off your mortgage, they charge you to get at your own money.
- Plus, if you lose your job or have a health issue, do you think the bank is going to let you refinance? Maybe or maybe not.
You can see that the answer to the question of paying off your mortgage before retirement is certainly not a slam dunk and depends on your personal financial goals. If this decision is something you are contemplating, please reach out to an SWA advisor as we are glad to help you make the choice that is best for you.