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Mortgages
The Mortgage "Pay Off" Dilemma
By Madaline Creehan
Vice President & Investment Consultant, Brand Asset Management Group
Quite often, and particularly when
approaching retirement, clients pose
the question if and when they should
pay off their mortgage. The answer
to this question not only has critical
financial considerations, but later in
life the emotional component often
takes precedence.
Undoubtedly, finally owning your home has tremendous
psychological value. Not only is it gratifying to own
rather than owe, but equally important is the comfort in
knowing that you have liberated yourself from debt.
After all, the pursuit of paying off your mortgage seems
endless at certain times in your life, particularly during
the early years when a larger percentage of the payment
goes to interest rather than principal.
Aside from the psychological value comes the reality of
when it makes good financial sense to pay off your
mortgage. For starters, try this simple calculation to find
the after tax cost of your mortgage. This results from
the deductibility of your mortgage interest. Multiply
your mortgage interest rate by your marginal tax rate
(6% x 35% = 2.1%). Then subtract that answer (2.1%)
from your interest rate to learn the after-tax cost of your
mortgage, which is 3.9% in this example. If, on an after
tax basis, the return on your investment portfolio is
expected to exceed your after-tax mortgage rate, the
obvious answer to this dilemma appears to be keep your
mortgage. But what about the risk?
The degree to which you achieve an after tax investment
return greater than the after tax cost of your mortgage
depends upon the risk/return characteristics of your
investment strategy and the vagaries of global markets.
After all, the expected after tax return of your
investment strategy should have the potential to
outperform your mortgage rate, otherwise why take the
risk? While low cost mortgage debt provides the
opportunity for investors to experience potentially
higher returns of the markets, with this opportunity
comes risk. Fortunately, the majority of our clients
refinanced to historically low interest rates over the past
few years. If not, the opportunity to lock in at a thirty
year rate below 6%, and an even lower fifteen year
rate, still exists for the time being.
If you think that now is the time to pay off your
mortgage, a critical decision must be made as to the
availability of liquid funds. From a tax perspective, it
generally does not make sense to pay off a mortgage
with funds from tax deferred accounts such as IRAs.
It can be too costly when you consider the tax
ramifications on the withdrawal.
Ultimately, making this decision depends on your
financial wherewithal, the emotional benefit, and the
potential opportunity as an investor. As always, we
are here to help guide you through these important
decisions.
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