This article was updated on May 10, 2017, and originally published on January 3, 2016.
Nobody wants to pay a mortgage longer than necessary. It’s a bit unsettling to have a huge debt burden for years that drives interest rates so high. You might even be tempted to pay off your mortgage early if you are lucky enough to have the cash lying around. However, paying off a mortgage early isn’t always the smartest decision, and there is a reason why mortgages are called “good debt.” So if you are thinking of paying off your mortgage early, here are three reasons to reconsider.
1. You will lose out on this interest deduction
There is an advantage in paying all of this mortgage interest and it is in the form of a potentially substantial tax deduction. If you are in a high tax bracket, losing this deduction could mean paying more tax, especially if the waiver promotes you to the next higher tax bracket. For example, let’s say you are in the 25% tax bracket and you are currently paying $ 24,000 per annum mortgage interest. That’s a $ 6,000 tax break that you would give up if you paid off your mortgage.
While some politicians have long sought to reduce or abolish the mortgage interest deduction, President Trump’s latest tax plan leaves that benefit fully intact. And while we don’t know what the future holds for the mortgage interest deduction, it doesn’t seem to be going away anytime soon.
2. You may have limited liquidity
The housing market is not particularly liquid. Buying and selling real estate takes a lot of time and effort; A contract can take weeks or even months. If you use your available cash to pay off your mortgage and make your home your only major asset, you will struggle to recover the high costs that you may incur. For example, if you lose your job, have a medical emergency, get married, or send a child to college, you want to have cash on hand. Moving shouldn’t be your only option.
On the flip side, if you take the money you would use to pay off your mortgage and instead spread it across a diverse investment portfolio, including stocks and bonds, you have more options in case cash is needed.
3. It will not bring any income
When you invest your money in stocks and bonds, you have the potential to generate a stream of income through dividends, interest payments, and capital gains. However, paying off your mortgage will not bring you any income. Instead, you have limited funds to invest. If you invest all of your money in your home, it can take years to appreciate, and paying back your mortgage could limit your ability to generate income for things like college, retirement, or other short- and long-term goals.
Everything revolves around interest
If your mortgage has a high interest rate and you have the cash to pay it off, you might as well get it off. However, if you have a low interest rate, you can take advantage of it by sticking to that mortgage and using your money to make higher returns elsewhere.
Let’s say you get a $ 100,000 mortgage at 4% interest. If you pay it off slowly over 30 years, you end up paying $ 72,000 in interest. This is a lot of money, so it is natural to think that any additional money should be used to pay down your principal.
But let’s say you stick to your 30 year payment plan, investing $ 240 each month – only half of your mortgage payment – and getting a decent return of 8%. In this case, your portfolio will grow to $ 352,000 by the time you have paid off your mortgage. So if you have a relatively low interest rate, it can certainly be worth keeping this mortgage, continuing to take advantage of the tax breaks, and investing excess money.
Also, remember that with a 30 year mortgage you are tied to a fixed rate for that period. If you have a low interest rate you can keep it as long as you carry that mortgage, inflation is damned. So why not let your lender take all the risk of inflation while you enjoy the benefits of an affordable monthly payment?
Now is the time to consider paying off your mortgage if you are about to retire. If you are about to retire, you should limit much of your portfolio to safer, less volatile investments. As you reduce your equity exposure and buy more bonds, you reduce the risk of catastrophic losses, but also your returns – to the point where they no longer exceed the interest rate you are paying on your mortgage. Hence, it is probably best to use excess money on mortgage payments.
Circumstances are different for everyone, so you need to collect some numbers and do some long-term planning before deciding how quickly to pay off your mortgage. If this debt is causing you ulcers and gray hair, then by all means pay it off ASAP. However, if you have many years of business ahead of you and a low interest rate on top of that, consider sticking to this mortgage and putting your excess money in the market. You can end up enjoying a much larger fortune and a richer retirement.