Many in the financial services industry will advise you not to pay down your mortgage. I can’t disagree more. Why? Because a mortgage is essentially the inverse of a bond:
- Bond: money you lend where the borrower pays you principal and interest.
It’s that simple. For example, the high-quality bonds I wrote about here recently, or bank certificates of deposit (CDs), will pay you roughly 2 percent. The average mortgage rate is about 4 percent. My conclusion is that borrowing money at 4 percent to lend it out at 2 percent is a bad idea.
But my industry colleagues offer some arguments to the contrary. The three I hear most often:
The mortgage interest is tax-deductible. While that’s true, in many cases it’s a better deal to pay off the mortgage. Why? Here’s a few reasons: If you don’t itemize on your tax return (the standard deduction everyone gets is currently $6,200 for a single filer and $12,400 joint), you are getting no benefit. Even if you do itemize, some of that interest may only be getting you to the standard deduction. For example, if you file jointly and have $15,000 of itemized deductions, including $5,000 from mortgage interest, the value of the deduction is only $2,600, the amount over the standard deduction.
If you’re a high earner (above $254,200 single and $305,050 joint), the mortgage deduction starts to be phased down (disallowed). And yes, though it’s true that you may pay more in taxes if you don’t have a mortgage, it’s much more important to make more money after taxes.
You shouldn’t put more money into your home. Paying down your mortgage isn’t putting a penny more into your home. I’m not talking about doing a remodel, I’m talking about paying the bank what you already owe them. How you finance your home has nothing to do with whether your home goes up or down in value. In fact, it’s a risk-free return.
You can earn more on your portfolio. This may end up being true, but remember that stocks are risky while paying down the mortgage is risk-free. You probably wouldn’t take out a margin account with your broker so you could buy more stocks, yet holding on to your mortgage so you can buy stocks is essentially doing the same thing. You have to compare your interest savings from paying down the mortgage to a risk-free rate that you could earn.
Always keep enough cash or liquid assets around for emergencies. How much you need can vary greatly according to how stable your income is from a job, a pension or Social Security. Another alternative to cash is to get a very low-cost home equity line of credit for any unanticipated cash needs. This merely gives you the right to borrow the money if you need it. Read the fine print, however, to make sure the bank doesn’t have the ability to lower the amount you may borrow.
My advice is to remember how banks make money. They borrow money through deposit accounts paying you very little, or CDs paying you a bit more, so they can lend you money at a higher rate. Also remember that financial advisers make money by investing your money. Everyone wants you to have a mortgage, but I say you earned the money and have no obligation to keep paying others.
I have personally never heard a soul tell me they wish they hadn’t paid off their mortgage. Have you?
Also of Interest
- ‘Boring’ High-Quality Bonds and Why You Need Them
- 6 Places to Never Use Your Debit Card
- Get Involved: Learn How You Can Give Back
- Join AARP: savings, resources and news for your well-being
See the AARP home page for deals, savings tips, trivia and more.