Paying off a mortgage might sound like the American dream, but is getting rid of those monthly payments a wise financial move?
In today’s market, with interest rates so low, some might argue that it’s best not to pay off a mortgage and instead funnel cash into higher-yielding investments. Others might argue the emotional satisfaction of paying off a mortgage is reason enough to go for it.
Vista’s take? There are many options when it comes to your mortgage. You can pay it off, pay it down, or keep it. Weighing the pros and cons of each option in light of your particular situation can help provide direction.
Pay It Off
There is something to be said for being debt free, whether you’re going into retirement or not. For some, paying off a mortgage is a meaningful goal. It can mean financial freedom and greater flexibility. Additionally, if the loan is several years old, the interest portion of payments and the associated tax benefits have diminished, making it simpler to just pay it off.
The tradeoff is the opportunity cost. Paying off a mortgage provides a guaranteed return—the cost of the loan. Could the money used to pay off the loan, however, earn a higher return in a diversified portfolio? Most likely, yes, but it is certainly not guaranteed.
In addition, homes are illiquid, so it’s difficult, time-consuming and costly to later tap the equity if a need for cash arises. Always check with your lender, as some impose a pre-payment penalty.
Pay It Down
A one-time additional principal payment reduces the original term of the loan and total interest paid. Some of our clients have preferred this approach, as it allows them to leave more of their diversified portfolio invested.
A mortgage recast, which reduces the mortgage balance through a large one-time payment, can also have appeal. With a recast, the lender recalculates the monthly payment based on the new balance using the same interest rate and time remaining on the original loan.
This can be a good option to both reduce the mortgage balance and the monthly payment.
The ability to recast a mortgage, and the costs to do so, vary by lender.
People who decide to keep it usually have a low fixed-rate mortgage. Interest rates of 3 to 4 percent are quite low by historical standards and also provide somewhat of an inflation hedge. As the cost of living continues to increase, the lender assumes that inflation risk while the mortgage interest rate remains fixed.
By keeping the mortgage, funds remain available to be invested in a low-cost, diversified portfolio that has the potential to grow at a rate that exceeds the cost of the mortgage. Folks who do this essentially become their own bank: borrowing at one (low) rate and investing at an expected rate that is higher.
To be clear, this approach focuses solely on the math—the difference between the mortgage interest rate and expected growth rate of a portfolio. It fails to consider the increased peace of mind, satisfaction from reaching a lifetime goal and financial freedom that comes from being debt free—particularly as one heads into retirement.
Find That Balance
When thinking about paying off a mortgage, the right answer will vary from person to person.
Finding that right balance by carefully assessing each person’s circumstances is essential to deciding whether or not to pay off your mortgage.
As always, we’re here to help.