Should you prepay your mortgage? 8 points to consider.
In an era of record mortgage rates, prepaying your mortgage can seem unnecessary. But it can make sense for many people, especially those who are retired or near retirement.
Remember: Even though mortgage rates have come down, falling to almost 3% on a 30-year fixed rate loan, they have also plunged for secure fixed rate investments.
If you pay off a mortgage at a rate of 3%, it’s like putting your money in a safe investment at that rate. Finding a safe 3% investment in today’s low-rate world – the 10-year Treasury bill returned 1.45% on Friday afternoon – can be difficult.
âEven if you have a 2% or 2.5% mortgage and you can’t get it anywhere else, it’s worth consideringâ paying it off sooner, says Natalie Pine, financial planner at College Station, Texas. âWith mortgage rates this low, it’s a trade-off.
One of Pine’s clients, Lacey Baze, 38, and her husband, Justin, last year paid off a mortgage at close to 4% on their five-bedroom, 3,600-square-foot home in College Station. âOur motivation was that we didn’t want to pay interest anymore,â Baze said. She said the couple were unable to find a guaranteed investment that would match their mortgage rate.
Some advisers tell their clients to invest their money in the stock market instead of paying down their mortgage. In the long run, stocks are expected to exceed what they pay in mortgage interest, they note. But that’s not sure, when your mortgage repayment is a guaranteed return.
There is no right answer. Paying off your mortgage is a personal decision that depends on your financial situation, your tolerance for risk and perhaps most importantly your attitude towards debt. Here are eight factors to consider.
Four reasons to keep a mortgage
You have other debts to pay. If you are going to be in debt, mortgage debt is the best type there is. You borrow to own an asset that tends to increase in value over time, rather than depreciating like a car, clothing, or household items. Mortgage rates are lower than most other consumer debt. And if you detail your taxes, you’ll likely be able to write off some of your mortgage payments, albeit less than before the tax law changed in 2017.
For these reasons, you should pay off all other debts before you think about paying or paying off your mortgage.
âThere is good debt and not so good debt,â says 84-year-old financial planner Cicily Maton of Chicago, who just paid off her own mortgage a year ago. âCredit card debt is not good. If you don’t pay it back every month, you have to find a way to do it.
This will leave you with no money. It is important to have cash to deal with emergencies that arise in life: a new home, a health crisis, a child who needs help. If paying off your mortgage quickly leaves you with no cash, you might be better off doing it over a period of several years.
âYou give yourself more flexibility by staying invested, you can withdraw it if you need to,â says James Basset, New York City financial advisor.
You can get better returns in the market. If you’re willing to take more risk, you can probably get better long-term returns in the market than by paying off your mortgage.
âOn average, you’ll do more with your investments than with your mortgage,â Bassett says. He says an investment portfolio is likely to return 6% or 7% per year over time, far more than current mortgage rates.
You want to protect yourself against inflation. Owning a home protects you from rising prices. However, owning a home with a mortgage is even better protection, according to economist Laurence Kotlikoff of Boston University. In a traditional mortgage, you make the same monthly payment over 15 or 30 years. If inflation gets out of hand, “you can pay it off in diluted dollars,” says Kotlikoff.
The United States has not experienced bad inflation for decades. But we have had a huge increase in public debt, especially during the pandemic. The annual inflation rate reached 5.4% this summer, well above its level of recent years. Many experts believe the spike in inflation is temporary and will subside in a few months. However, if they are wrong, owning a home with a mortgage might seem smart.
Four reasons to pay off a mortgage
You need to cut spending in retirement. When you work, your income tends to increase as you move up the career ladder. There are annual bonuses for many workers. If you change jobs, you will likely get a raise. Retirement is not like that. Even high-income people are likely to live on less money than when they were working.
If you’re struggling financially in retirement, it’s often easier to cut expenses than increase your income, especially in a low-interest environment.
The biggest fixed expense most people have is their monthly mortgage payment. If that goes away, they can live on a lot less money.
You have a low tolerance for risk. Many people, especially retirees, are unwilling to live with the ups and downs of owning stocks and other risky assets. Yes, stocks are likely to outperform over the long term. But it is not certain.
âPeople think that if they have a mortgage rate of 2.5%, they will surely get a better return over the next 15 years in the market,â says financial advisor Mark Fonville of Richmond, Virginia. âBut it’s not a certainty. It took 14 years for the market to recoup its losses after the crash of 1929. What is certain is to pay off your mortgage. You know you are saving yourself 2.5% â
You can sell low yielding bonds. In today’s low interest rate environment, owning bonds is almost painful. But suppose you decide to sell $ 200,000 of bonds at 1% and pay off a mortgage of $ 200,000 at a rate of 3%.
If you only look at your investment portfolio, it will have a higher percentage of stocks than before. But if you look at the whole picture of your financial life, you are not taking more risks. You sold an asset of $ 200,000 that was earning 1% and you paid off a liability of $ 200,000 that cost you 3%.
You hate having debt. Even in a debt-crazed country like the United States, there are millions of people who love the idea of ââowing nothing. Paying off the mortgage for them is big business.
âWe’re not just talking about math,â says Brian O’Neill, a financial advisor from Niceville, Fla., Whose clientele consists primarily of military families. âWe’re talking about what it feels like to have a paid home. “
Alicia Sher, an Atlanta-area financial advisor, says she generally tells clients they can get better returns in the market than paying off their mortgage. But she adds, âThe peace of mind factor is really important. A lot of people like the idea of ââhaving no debt and having a mortgage.
Ultimately, peace of mind trumps all other factors when it comes to deciding to pay off your mortgage. Yes, you might just end up with more money playing the market, but you might get deeper psychological satisfaction from getting out of debt for the first time in your adult life.
If so, pay off your mortgage. You are not wasting money because mortgage rates are so low. And you are certainly not going to derail your retirement or your financial goals by getting rid of a mortgage.
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