- Paying off a mortgage early could reduce overall interest paid over time
- Investing the funds could yield a better return than mortgage interest saved
- With interest rates changing, it may be time to reevaluate your options
Entering retirement with the mortgage paid off is a common aspiration. Paying off a home loan even sooner than that can be tempting too. Should you increase home mortgage payments and save on interest? Or invest the extra cash in the hopes of better returns? It’s a decision that should be weighed carefully.
“The question of whether to carry a mortgage into retirement has two distinct components: emotional and rational,” says Mike Greene, Senior Vice President of Financial Advice at Ameriprise. “A home represents so much more than the return you might get from it — it’s where you raise a family and create memories,” Greene says.
On a purely rational level, a home is like buying an investment: You take out a loan, buy a home, make payments and hope it appreciates in value. But, as we were reminded in 2008, investment markets don’t always go up, and neither do home values.
Setting emotions (and market unpredictability) aside, here are three considerations to keep in mind if you’re thinking of paying off your mortgage early.
“The question of whether to carry a mortgage into retirement has two distinct components: emotional and rational.”
1. Weigh the interest vs. invest decision
“The return on paying off your mortgage early — either through regular extra monthly payments or by occasional lump sums — is the amount of money that would have been paid in interest,” Greene says. “What you don’t know is the return you would have gotten on the money had it not been used to pay off the mortgage.”
That question often proves to be an irresistible siren call to invest for homeowners. “Many people calculate based on their risk tolerance and portfolio allocation, assuming they can earn more back from the market than they pay out in mortgage interest and save with tax deductions,” Greene says. This means that younger investors — who have more time to benefit from market returns — may choose to invest the money they would have used to make extra house payments.
That said, interest rates aren’t as much of a make-or-break factor as homeowners may think. Greene notes that when mortgage interest rates are low, expected returns in the stock market can also be lower. This is particularly true for people nearing retirement, who tend to reduce their exposure to risk by investing in fixed-income rather than equity products.
Pay off or invest 100k1?
2. Factor in unexpected events
In theory, a homeowner’s cash flow is improved by saving money instead of spending more on extra mortgage payments, which enables them to better deal with unexpected expenses such as a health event. But if those expenses are severe enough to drain your cash reserves, you get hit with a double whammy: Savings are depleted and your home could be at risk because you can’t afford mortgage payments.
“Before even considering paying off your mortgage, make sure to fund savings and retirement accounts and pay off other higher-interest loans,” Greene adds. “If you’ve paid off your home, I strongly recommend setting up a home equity line of credit as soon as possible in case you need liquidity down the road,” Greene advises. “In an emergency, you could access the equity in your home.”
3. Get a second opinion
With so many factors at play, even the savviest of investors would be wise to consult with a third party before making any mortgage-related decisions. “I would include two professionals: your financial advisor and a tax consultant,” Greene says.
Bringing a tax professional into the discussion is invaluable for understanding how retaining or paying off your mortgage will affect your tax situation, a component that is often more impactful than homeowners may realize.
An advisor can help you explore other scenarios based on income, savings, lifestyle, expenses and risk tolerance.