The Mortgage "Pay Off" Dilemma

The Mortgage 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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