If you’re able to pay off your mortgage early, should you do it?
It seems like a simple decision, but there are actually many sides to the story. CNBC asked several advisors to weigh in, and they came up with a number of pros and cons.
When it’s wise to pay it off
“I recently talked my own mother into paying cash for a new home, as she is entering retirement,” said Elizabeth Grahsl, certified financial planner and vice president at Prosperity Bank. “The downsides are that she has to recognize a fair amount of capital gains to sell enough assets to pay for the home outright … [and] she’ll lose the mortgage-interest tax deduction.”
But the downsides are nothing compared to the interest and closing costs she’ll save, said Grahsl, compared to even a 15-year mortgage.
“And because her retirement expenses will be so much lower without a mortgage, she won’t need to withdraw as much from her portfolio for income,” she added. “That will save her income taxes and capital gains over the coming decades, as well as enable her to retire with a lower portfolio value.”
Grahsl generally recommends that people near or in retirement pay down their mortgages rather than invest more in stocks or bonds. While mortgage interest rates are low, she said, the market is near all-time highs, and both stocks and bonds seem overvalued.
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“Over three-plus decades, I do think the market will outperform today’s mortgage rates,” she said. “But retirees don’t need to take that gamble.”
Russ Weiss, a CFP with Marshall Financial Group, offers both pros and cons. The pros include:
- Peace of mind. “A lot of what I do is managing behavior vs. managing investments,” he said. “If paying off a mortgage means the client is less likely to panic with their portfolio value down, I am inclined to recommend it.”
- Good savings vehicle. “Some clients are not good savers,” Weiss said. “By paying off the mortgage, it creates a form of forced savings.”
- Taking more risk in the overall portfolio. “By paying off the mortgage, it allows us to revisit the investment portfolio structure and allocate more money to stocks.”
When it’s wise not to pay it off
Weiss also lists several reasons for not retiring a mortgage early, including:
- Leverage. “By borrowing for long periods of time at low rates and investing the difference, the client will most likely end up with more wealth versus paying off the mortgage.”
- Right-sizing debt. “People typically buy too much house and therefore take out too much of a mortgage,” he said. “If paying off the mortgage is a concern, they should consider the possibility they purchased too much house. The right amount of debt is favorable to long-term wealth growth, assuming a low-interest-rate environment.”
- Inflation hedge. “Paying off the mortgage does not help to provide income,” Weiss said. “Plus, the bank takes all the risk. Over a 30-year history, assuming the borrower makes all the monthly payments, the bank can never call the loan. This provides for a fixed payment for 30 years that will never change. Taking inflation into account, it’s possible that 20 years into the mortgage, the payment will be equivalent to an electric bill or similar.”
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There could be individual retirement account-related advantages to not paying the mortgage off, said Julie A. Schatz, CFP and partner with Investor’s Capital Management.
“If the client is retired and their adjusted gross income is relatively low,” she said, “then having a mortgage interest deduction [along with property tax, maybe charitable contributions, etc.] on their Schedule A will reduce their taxable income even further and allow more room for tax-efficient Roth conversions.”
“Far too many clients focus on paying off their mortgage in retirement, only to end up ‘land poor.'”
Don’t retire the mortgage early if you’re not staying put, said Kristi C. Sullivan, CFP and owner of Sullivan Financial Planning.
“If a client thinks they will be in a house for 10 years after the mortgage payoff, I encourage them to do it,” she said. “But if they want to move soon after they are able to pay off the mortgage, I don’t.”
“It’s great to save the interest, but not at the expense of liquidity if this is not your forever house,” Sullivan said. “Why pay $20,000 in interest to get $6,600 back from the IRS?”
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For his part, David Mendels, a CFP and director of planning at Creative Financial Concepts, said that “far too many clients focus on paying off their mortgage in retirement, only to end up ‘land poor.'”
“Especially at today’s low rates,” he added. “I urge them to think less in terms of the added payment than of the added safety net of the extra cash.”
The only exception to this rule is if the money is going to “burn a hole in their pockets,” Mendels said.
—By Deborah Nason, special to CNBC.com