Should You Pay Off Your Mortgage?

One of the best financially freeing moments in life is the day you compare your savings and mortgage principal balances and realize that you could pay off your mortgage if you wanted to.  If you’re at that point, congratulations!  If you’re not there yet, keep saving; it can come sooner than you think.

Of course, immediately following the discovery of being able to pay off the mortgage comes a question: should I?  Here’s how you decide:

First, consider what you would do with the money if you didn’t pay off the mortgage.

Would it sit in savings, be invested for long-term retirement goals, or something else?  Based on your plans if you didn’t pay off the mortgage, you can estimate a rate of return you expect to receive.  From this rate of return, you’ll need to subtract taxes paid on the earnings (15% if capital gains, your income tax rate if regular interest).

Second, figure out what your mortgage is costing you.

Look at your interest rate, calculate the annual interest expense, and subtract any income tax savings you’re receiving.  Be sure to avoid over-estimating the benefits of tax savings.  For example, if your mortgage interest is $5,000 and you have another $8,000 of itemized deductions, your total itemized deductions are $13,000.  If you’re married filing jointly, the standard deduction is $11,400 this year.  So the mortgage interest is only increasing your deductions by $1,600.  If you’re in the 28% tax bracket, this equates to a $448 tax savings.

Third, compare your answer in step 1 with your answer in step 2.

If it’s costing you more to keep your mortgage than you would earn with the money invested or in the bank, then you should generally pay off the mortgage.  If you can get a greater return on your investments than what your mortgage is costing you, then you should generally keep the money invested and wait to pay off the mortgage.

Of course there are exceptions and other considerations including:

If you would be taking the pay-off money out of a pre-tax IRA or deferred compensation in a lump sum, take a really close look at the tax consequences of that lump sum withdrawal!  They can often totally cancel out any savings on the mortgage interest.

If you would be using “retirement” savings funds to pay off the mortgage, you really need to look at your retirement projections and ensure that they still work with the funds withdrawn.  If your projections rely on you beginning to save what you’re currently paying on the mortgage, know yourself.  Will you stick with this savings program?  If not, probably best to just keep your retirement funds intact and continue paying the mortgage.

If paying off the mortgage would take your emergency funds dangerously low or short-change funds for other important goals, it’s likely not a good idea.

Making your decision

While it seems like a fairly straight-forward question, when you think about the whole picture, you realize there are lots of what-ifs and options to consider.  The important thing is to take time to do your homework, complete the analysis, and seek professional assistance if needed.

Even if the process reveals you’re better off with the mortgage, you might still want to go ahead and pay it off because of the peace-of-mind benefit that comes from not having any debt.  If that’s the case, by going through the process thoughtfully and thoroughly, you will know what you’re giving up financially for that peace of mind so you can make an informed decision about whether it’s worth it to you.

And if the process does show that you would be better off getting rid of that mortgage, you can move forward with confidence.

Of course, everyone’s situation is different.  While the process described above addresses many considerations, you may have some issues not addressed here or that are unique to you.  Make sure you fully consider your own situation before making any decision.

About the author

Jean Keener, CRPC®, CFDP®

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