I know it’s sacrilegious to suggest that you should always have a mortgage . Conventional wisdom says that paying off your mortgage early is always a good idea. After all, the sooner you pay it off, the sooner you’ll put an end to your house payment. That’s true financial peace of mind! And chances are, if your house is paid for you’re probably completely debt-free. Good deal?
Not so fast!
By recognizing that all of the above are good places to be in life, there are at least four reasons why you may not want to pay off your mortgage early.
A 4% interest rate (approximately)
In the past couple of years millions of people have refinanced their homes and are now carrying mortgages that are around 4%, or even less. That’s more than a little bit of a game changer as far as paying off a mortgage is concerned.
3.-something percent on a mortgage is more than just a low rate – it’s the lowest mortgage rate in recorded history! Do you really want to give that up?
If you have a 30 year mortgage, that means you have locked in that record low rate for the next three decades. Should interest rates rise – and they will soon enough – you may find that you’ll be able to earn 5% or 6% in safe investments like certificates of deposit or treasury bills, while you are paying the sub-4% mortgage on your home. That will be a guaranteed return on your mortgage money!
I have a feeling a lot of people will be kicking themselves for having paid off their mortgages in just a few years.
You’ll lose one of the last remaining income tax deductions
Tax deductions just aren’t as rich as they once were. Credit card interest used to be deductible – it isn’t anymore. Last year, medical deductions were subject to a reduction of 7.5% of your adjusted gross income; for this year and beyond, the threshold is rising to 10%. Many thousands of taxpayers will lose their medical deduction as a result.
In an attempt to deal with the country’s fiscal issues, the government is slowly but steadily reducing income tax deductions. One of the last relatively safe deductions is the mortgage interest deduction. Considering that your rate is probably right around 4%, if you have a marginal tax rate of 40% (combined federal and state), then your effective mortgage rate is also reduced by 40%. This will turn a 4% rate into 2.4%. Is there any other type of loan that you could borrow at such a low rate of interest?
And in regard to tax inductions, you also have to consider that if you payoff your mortgage – and lose your mortgage interest deduction – that could also put you below the standard deduction, eliminating your ability to itemize. This can be a bigger problem than you think – some states have a lower standard deductions than the IRS allows. If you are forced to use the standard deduction for federal tax purposes, you will generally be required to use the standard induction for your state as well. If your standard deduction at the state level is say, $3,000 (as it is in Georgia), you’ll pay considerably more in state income taxes as a result of losing the ability to itemize your deductions.
People often underestimate the importance of liquidity in their financial profile. Liquidity is the amount of money that you have that is not tied up in investments or consumer goods. If you sink six-figures in cash into paying off your mortgage early, you’ll be giving up a huge chunk of liquidity.
That will be money that you will not have available to meet emergency expenses, to payoff other debts, or to make other major purchases – such as a car – with cash, rather than going into debt.
Investing money in non-housing
Staying with the idea of sinking six-figures in cash into paying off your mortgage early for a moment, have you ever thought about the opportunity cost of having that much money tied up in your house? Opportunity costs as in, what else can you do with that money that might be even more profitable?
Investing it is definitely one possibility.
Given that the stock market has historically returned something on the order of 8% per year over the very long term, it would seem to make more sense to invest a comparable amount of money into stocks rather than into paying off your 3.-something percent mortgage. That could provide you with a rate of return on your money that is more than 4% above what you’ll be saving by paying off your mortgage.
Neal’s Note – I am not a fan of borrowing money (having a mortgage) to invest in the stock market or other types of investments like social lending for the potentially higher return . Let’s not forget about the relative risks involved. Something to consider.
Back when mortgage rates were around 7%, 8%, 10% – and certainly well into double digits – paying off your mortgage early made overwhelming sense. But now that rates are at historic lows… you might want to give the matter some more thought.
Do you think that current extremely low mortgage rates should have an effect on a person’s decision to payoff their mortgage or not?
I don’t think there’s any evil attached to having a mortgage. IT’s typically cheap money and it’s backed by a hard asset. You should focus on getting rid of all your other debt before even considering paying off a mortgage. Even then, you should do a good analyses before paying it off (assuming your in a position to do that).
I agree! For me liquidity is important. I will have a paid off asset in about 4 years that has a market value in $400K range today. At the height of the bubble it was approaching $700K. I want access to the equity. Ido in the form of a HELOC, but it is small compared to the equity.
Matt from Saverocity says
I think there should be a differentiation between a mortgage for primary residency and one for rental investment property. The latter I would mortgage and run a separate P/L on as a standalone entity.
The primary residence though, I would rather have that paid off, because it is more than an asset, it is where you sleep at night too. Paid cash for my place, will mortgage rentals.
Kurt @ Money Counselor says
Well I don’t know; just because something is historically cheap is not necessarily a reason to buy.
A $200,000 30-year mortgage @3.75% will cost the ‘buyer’ $133,443.23 in interest. Agreed, if one can itemize deductions (and if the mortgage interest tax deduction remains unaltered–a big question mark), the after-tax cost will be somewhat less. While low historically, $133k is still a lot of cash I think. During those 30 years a $926/month mortgage payment will be due each and every month, regardless of layoffs, disability, health challenges, etc. In other words, debt always equals risk, and that needs to be factored into every borrowing decision.
To each his own, but given my perception of the risk/return prospects of various investments these days, a 3.75% guaranteed, risk-free return on paying down or off a mortgage looks pretty appealing. Sure, you could do better investing $200k in stocks over the next 30 years, but you could also do worse, and you’d definitely be taking a lot more risk. The S&P 500 is at about the same level today as it was in 2000–13 years ago. Those of us who paid off a mortgage in 2000 instead of investing the same in stocks are very pleased with our decision. 🙂