Mortgage vs. savings a personal as well as financial decision
Q. I’m 28, single, and just received an $86,000 inheritance. I don’t know if I should pay off my mortgage ($79,836) or invest for retirement. If I pay off my mortgage, I’ll lose the tax deduction. Any thoughts? – Angela P.
A. This is always an interesting question. Here are several ideas to consider.
First, everyone needs an emergency cash reserve equal to three to six months of their living expenses. It should be held in a safe, liquid account, such as bank savings or money market deposit accounts, or a money market mutual fund. First and foremost, your emergency cash reserve must be funded.
Second, all taxpayers can take the greater of their itemized deductions or the standard deduction when calculating taxable income. Itemized deductions are real expenses, like mortgage interest or charitable contributions. The standard deduction is a “plug-in” amount. You can take it even if you have no itemized deductions. In 2010, the standard deduction is $5,700 for singles, $11,400 for married couples.
If mortgage interest causes itemized deductions to exceed the standard deduction, it may be worthwhile. For example, if it causes your itemized deductions to exceed the standard deduction by $2,000 and you’re in the 15 percent tax bracket, you’ll save $300 in income taxes. Over time, mortgage interest loses value as an itemized deduction because the standard deduction adjusts annually for inflation and more of your mortgage payment is principal, not interest.
How meaningful is mortgage interest to you? Your answer will weigh in favor of keeping your mortgage or paying it off.
Third, it takes “income-producing” assets to retire, securely and comfortably, and Social Security may look quite different when you retire. So it’s important to start saving and keep saving for retirement.
Long-term, you might expect a balanced portfolio (50-60 percent stocks, 40-50 percent bonds) to provide a net return of 7 percent per year and your house to keep up with inflation, which has averaged 3 percent per year. You might save more for retirement if you invest the money, but you might not.
That said, you are guaranteed to “save” interest dollars if you pay off your mortgage. For example, if you have a $79,836 mortgage at 5 percent for 30 years, you’ll save $74,452 in interest and that money can be saved for retirement.
If you pay off your mortgage, can you still save enough for retirement? Sure, you can always sell your house, but you need a roof over your head, and whether you rent or own, it will cost money.
Finally, paying off the mortgage isn’t just a financial decision. In my experience, clients (especially single women) who can pay off their mortgages and still have enough savings for retirement have a great sense of personal pride and confidence.
But this is not the reality for many people, and they need to choose. Which would make you feel the most optimistic and energized about your financial goals and working toward them?
Greer Gibson Bacon is a certified financial planner and member of the local Financial Planning Association chapter. Readers are invited to submit questions on financial planning to be answered in this space each Tuesday. Send questions to email@example.com.