When to Pay Off Your Mortgage
When I bought my first home nearly 20 years ago, I faced the questions most first-time homebuyers agonize over:
What size mortgage/payment can we afford?
How long do we see ourselves in this house?
Should we lock in the interest rate long-term or go with a cheaper adjustable rate?
Now, as I approach my third decade of homeownership, I stress over a similar, but new set of questions:
Now that we have extra cash flow, should I speed up the pay-off of my mortgage?
Do we see ourselves retiring in this house and do we want a mortgage?
Should we take advantage of historically low rates and high home values and do a “cash-out refinance” and lock-in a low rate as a hedge against inflation?
And the answer remains for most of these questions (drum roll, please)….…. it depends.
There is no right answer, as it will depend on your goals and objectives along with your target for returns coupled with tolerance for risk and volatility.
Generally speaking, the following are reasons to maintain your mortgage:
You have other higher interest rate debt. A first mortgage on a primary residence tends to be the best debt you can have due to the relatively low interest rates, deductibility of the interest payments, and the fact that the debt is secured by an asset that should increase in value over time. If you have debt on a depreciable asset, such as cars, or purchases on a credit card, which tends to have the highest rates, or even student loans, you should typically focus on paying off those debts first.
To provide and maintain liquidity. Having your net worth locked up in your house will provide minimal comfort in a time of emergency or crisis. Make sure you have healthy, liquid savings that you can access in a moment’s notice before you pay down your mortgage with your savings. You should also consider adding a Home Equity Line of Credit (“HELOC”) as a safety net to provide liquidity when needed.
You can accept and tolerate the risk and volatility in other investment assets. Whether or not you pay down your mortgage, will not affect your participation in the appreciation of your home value. But, borrowing against your home at an interest rate lower than your expected return on other investments, such as the stock market, could allow you to increase your overall IRR and grow your net worth faster than paying off your mortgage.
You are afraid of the current inflationary environment. Locking in a low, fixed-rate, amortizing mortgage is a great hedge against inflation, especially as the government plans more spending in the upcoming years. Currently, inflation is hovering between 5% - 6% annually. A fixed payment with a 3% interested rate can provide significant peace of mind until this inflationary cycle ends.
Generally speaking, the following are reasons to pay off/down your mortgage:
You need/want to reduce expenses during retirement. During retirement, you are no longer receiving those annual salary increases or bonuses. Paying down, or even off, your mortgage can help you control your monthly expenses.
You have a low tolerance for risk. In theory, when you retire, you should no longer need to accumulate more assets. Paying off your mortgage, and effectively earning 3% - 4% by not having a mortgage, could easily fall within your return and risk goals and objectives.
You have sufficient liquid, conservative, low-return assets. In the current low-rate, inflationary environment, any cash sitting around is barely eking out a nominal return and is definitely earning you a negative return. And holding low-interest rate bonds puts you in the same situation, but with interest rate risk, as bonds appear poised to rise. If you can swap a low yielding asset to pay down debt with a higher interest rate, this swap can improve your overall financial health.
Emotionally you can’t handle having a debt. At the end of the day, peace of mind, not just financially speaking, is what is most important. If paying off your mortgage lowers your stress and helps you sleep at night, then by all means, do it. There are many paths to a successful retirement. Such a path can easily be one that does not include a mortgage.