According to a report published by the Consumer Protection Financial Bureau titled Snapshot of Older Consumers and Mortgage Debt, “the percentage of homeowners age 65 and older carrying mortgage debt increased from 22% to 30% from 2001 to 2011”. For homeowners older than age 75, the percentage with mortgage debt has more than doubled too.
Considering that more and more Americans are going into retirement with mortgage debt, it isn’t too surprising that one of the most frequent questions clients ask is whether or not to pay off their mortgage.
Mortgage rates today are less than 4% for a 30-year fixed mortgage. Depending on your risk tolerance, time horizon, and comfort level with the stock market you can make a good argument for having a mortgage even if you can afford not to.
If you can earn more than 4% on your investments over the life of your mortgage, why not keep the mortgage and invest the difference? That’s the argument anyway.
For most of my clients, who are typically age 50 or older and within 10 years of retirement (or already retired), I usually recommend paying off the mortgage as soon as possible. Here’s why:
Your home is the foundation of your retirement plan. Having a house that is paid for may not be the best way to accumulate assets or grow your net worth over time, but it’s one of the best ways I know to create financial security.
When you get to be “a certain age”- whatever that may be – the emphasis eventually shifts from accumulating as much as possible, to protecting what you have. Having a home that is paid for is a great way to do that.
Money might be cheap, but it’s not free. Albert Einstein once said, “compound interest is the eight wonder of the world”. He was referring to the benefit you get by compounding the interest on your investments and savings over time. He was right. This is why financial advisors often recommend getting a mortgage and investing your monthly savings elsewhere.
But it works in the other direction too. A $100,000 mortgage at 4% interest over 30 years will cost you $476 per month or $171,289 over the life of the loan. That’s $71,289 of compounded interest that goes to the bank, not you. While you may do better than that with your investments, there is no guarantee. The only guarantee is that you will pay the mortgage company an extra $71,289 for every $100,000 you borrow.
But I need the tax deduction. No, you don’t. I hate paying taxes and I believe you should do everything reasonably possible to keep your tax bill as low as you can. However, it doesn’t make sense to borrow money at 4% just to be able to deduct the interest on your tax return. You are still paying for the cost of borrowing (4% less your tax rate, in this example). Borrowing money always costs you money. It’s just that with the tax deduction it may cost you a little less.
Plus, as your mortgage gets paid down your tax deduction becomes smaller even though your payment stays the same. This is because in the early years of your mortgage most of your payment is tax-deductible mortgage interest. In later years, the majority of your payment goes to your principal and less of it is tax-deductible. So the tax deduction becomes less meaningful over time.
If you are comparing your mortgage interest rate to what you could make in your investments, you are probably comparing the wrong numbers. The argument in favor of keeping your mortgage assumes your investment return will be more than your mortgage rate over time. That may be true on some investments like stocks, but it isn’t true on everything.
For example, how much are you earning on the cash in your savings account? What about your CDs? Own any bonds? What are they paying? The real comparison shouldn’t be between your mortgage rate and your favorite stock fund, but between your mortgage rate and what you are earning on cash and bonds.
Odds are your cash, CD’s and bond funds are paying you a lot less than what you are paying the bank to borrow their money. Paying off your mortgage is like getting a guaranteed 4% rate of return on your lowest paying investment – usually your cash, CDs and bond funds.
Home equity is a great college planning strategy. If you have kids that will go to college, you will have to fill out the Free Application for Federal Student Aid or FAFSA form. This is the standard college financial aid form that parents and students fill out when applying for financial aid. Some assets are exempt on the form and are not included in the calculation of what you are expected to contribute towards college expenses.
One of those assets is your home – not your lake cabin or rental property, but your primary residence. In theory, you could have a multi-million dollar home that is paid for and it will have no effect on your financial aid award. For some families, especially those who may be good candidates to receive need-based financial aid, paying off your home can be a great way to increase your eligibility to receive college financial aid.
How long do you really want to make mortgage payments? One of the benefits of getting a mortgage is that eventually it gets paid off and you can live mortgage free thereafter. At age 51, I have no interest in extending my mortgage payments out another 30 years – or even another 15, for that matter. After making rent and/or mortgage payments for the last 30 years I am ready to be done. The last thing I want is to extend that period out any farther than I have to. Do you really want to be the one 75 year old out of five that still has a mortgage payment?
To be fair, having a mortgage at today’s low rates isn’t a bad idea, especially if you are young or are just getting started with your savings and investment plan. But if you have significant assets, retirement plans, IRAs, cash reserves, etc., including a home that is paid for as part of your wealth management strategy can go a long way towards creating the lasting financial security you want in retirement.
Please Note: Investing is subject to risks including loss of principal invested. No strategy can assure a profit against loss.