Is This a Good Time to Pay Off My Mortgage?
This is one of the most frequently asked questions I have heard over the years. Just today, a tax preparer in my building stopped by my office to ask the same question. She told me that she has been getting a lot of calls lately from her clients who have sold an asset, gotten a bonus or inherited some money. She wanted to know if there was a rule of thumb that she could share with her clients that would let them know if it made sense or not to pay off the mortgage.
Since making the wrong decision in this regard can have a very negative impact on someone’s retirement security, I decided it was time to revisit this topic. First some background:
Avoiding the Tough Choice
Several years ago, I wrote a post called; “Should I Stay or Should I Go? Tough Choices for Retirement” to look at how people get to the point of being forced to sell their home to afford their living expenses and care. Since this has been a recurring issue for retiring people, especially here in California, I did some research and analysis several years ago and found that one of the common threads was that many of these folks had either paid cash, accelerated their mortgage to pay it off sooner or used a shorter-term mortgage loan (15 years or less). It turns out that sending those extra payments to the mortgage holder instead of saving for retirement made a big difference in the amount of resources they had available to pay for their lifestyle.
Balance is the Key When it Comes to Your Retirement Savings
To succeed financially over your lifetime, one must create a balance between current lifestyle and enjoyment and future financial security. We all know this but figuring out how to achieve it is another thing. If you cut too much now to save for retirement, you might miss out on great experiences and opportunities, spend too much now and you will get to retirement without options. This is why the decision to pay off your mortgage is so crucial.
All Debt is Not Created Equal
I spend a lot of time with clients getting them out of debt. Our economy makes it very easy to spend money you don’t have. I call this “spending in advance”. When you spend in advance, you are spending money that you think you will have in the future, so you borrow now so that you can enjoy today what you can’t afford. This is usually when you borrow for the purchase of “stuff” like cars, clothes, appliances, vacations, etc..
Think credit cards and consumer installment loans. This is the kind of borrowing that will get you in trouble. Usually high interest rates paying for things that lose value is the route to problems and a significant drain on your wealth. I spend a lot of time helping clients who are in this position to get to a position of “spending in arrears”, which means having the money to spend on those things BEFORE you buy them.
What is Collateralized Debt?
The other main type of debt is collateralized debt. This is debt taken against assets that can hold value and have the possibility of appreciation. These kind of debts are things like mortgages and life insurance policy loans. This type of debt, when managed properly, can reduce risk exposure, improve liquidity while increasing rates of return and your ability to respond to opportunities and challenges that come up over your lifetime.
I have often said that I look to math and science when analyzing strategies, so let’s look at some economic factors that should enter into your decision as to whether or not you should pay off that mortgage.
Economic Factors to Consider When Deciding About Paying Off Your Mortgage
First ask yourself this question; if you had an opportunity to invest money in something with low liquidity, could lose principal and guarantees a ZERO percent rate of return, how much would you like to invest? Got your answer, let’s dig in to those topics.
When money is tied up in your home equity, you have a gate keeper standing guard that must give you permission to get at your money. You either need a banker to allow you to take a loan against your equity, or a buyer to purchase the property from you. Otherwise, the home equity won’t help you pay the bills or put food on the table. That equity must be converted to cash in order to be spent.
Before you think to yourself, “well I have a home equity line of credit (HELOC), so I can get at my equity any time I want”, think back 10 short years to 2008, when nearly everyone with available credit on their HELOC’s had the credit line reduced to the amount of the outstanding debt. And if you wanted to sell, buyers were striking very hard bargains and paying very little to desperate sellers.
You Could Lose Money
I know many people around here don’t believe that home values ever go down. As I have written before, there are lots of people who think their house has been their best performing asset, which clearly isn’t true. Heck, my house in Mill Valley has nearly doubled in value since we purchased it 14 years ago. That seems impressive, but it is only slightly more than 5% annualized appreciation! I have done better than that during the same period, with many of the investments I own.
Given historically high prices in many parts of the country, more than just California may see a drop in values over the next few years as interest rates rise. I have one client who recently had to reduce the price of their home more than 20% (from the original purchase price over 10 years ago) and it still took 15 months to sell!
Guaranteed Zero Percent Rate of Return
I hear all the time how someone’s home has been their best performing asset, while I won’t debate that here, the home appreciates, or depreciates regardless of the amount of debt. If you have 2 identical homes next to each other and one person pays cash and the other puts the cash in an account but takes out a mortgage and the values in the neighborhood rise by 10%, both homes will appreciate by 10%, regardless of whether there was a mortgage or not. This proves that real estate equity earns nothing.
Pay Off the Mortgage Quicker and Safer, at a Lower Cost
With all that said, we want you to pay off the mortgage as quickly as possible, just not in the way most folks think it needs to be done. If you have a $500,0000 mortgage and a $500,000 liquid account, then there is no net debt on your balance sheet. By taking that equity and earning even a small rate of return (less than 4% in many cases) you will be able to pay the mortgage off much faster. But here is the kicker, YOU will be the one in charge of your equity. There will be no gatekeeper to contend with should you need to access the money for opportunities or emergencies.
You’re in Control = Less Risk
If you control the equity, then you have less risk. In fact, if the example above was to have both homes depreciate by 20%, the person with the mortgage and in control of the equity, will suffer much less of a loss, since the equity is diversified from the equity of the home.
Also, if I offered to lend you $1 with the terms of paying me back later with dollars that were worth 50 cents, how many dollars would you like to borrow? Well, if I pay back my loan over 30 years, and we average 3% inflation, 24 years from now the dollars you pay to the bank will only be worth 50 cents of the value of today’s dollars!
Why would you give the bank more valuable today dollars and keep the less valuable future dollars for yourself? Heck, the bank understands this which is why they are encouraging people to take 10 and 15 year loans, it is much better for the bank.
Summing it Up
If your home only represents 10% of your net worth or less, then paying off your mortgage early won’t have much impact on your financial security. (Many people who are in that situation would never pay off their mortgage as a wealth management and control technique. They understand how important control and diversification of risk are).
If the value of your home represents a significant portion of your net worth, then making the wrong decision on paying off your mortgage can be very detrimental to your wealth. You can increase risk, decrease control, increase taxes and reduce the net performance of your overall wealth by paying off your mortgage to the bank.
We Can Help You Answer This Important Question
If you would like to understand your mortgage better and learn how to manage your home as an asset that increases your financial security instead of undermining it, give us a call or contact us through our website and we can schedule a time to talk about your home and paying it off quicker, with less risk.
Special Free Offer for Reading This Article
If you have read this article and mention it, I will provide you a Mortgage Master® analysis at no cost. This will provide the mathematic analysis that will help you to make better mortgage decisions on your road to a Happy Retirement!
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.