It’s been drilled into Americans that a mortgage is good debt, a liability that shouldn’t give you pause, even after you retire.
But the pandemic has been shaking up a lot of old financial rules. The “Great Resignation,” as it’s being called for those quitting their jobs, is making a lot of homeowners wonder if they should consider paying off their mortgage early.
A record 4.3 million U.S. workers quit their jobs in August, according to data from the Bureau of Labor Statistics. With COVID-19 still surging in areas, working comes with health risks for many people. The pay isn’t enough to offset the possibility of getting COVID-19, so they quit. For others, the pandemic death toll has made them wonder if their work took too much precedence over living their best life.
While not everyone who quits can afford to get rid of their mortgage early, for those who have the option, the question is: Why not?
I spoke with two experts to get their take on the pros and cons of paying off a mortgage early. Let’s start with some of the cons.
Being house poor – “I owe just under $80,000 on my home mortgage,” one reader wrote. “I am retired, and I have the cash to pay the loan, but it will wipe out over half of my savings. I am on track to pay the mortgage in less than three years.”
As much as you may want to rid yourself of your mortgage, don’t do it if you’ll leave yourself with an inadequate savings cushion, said Michael Roberts, a professor of finance at Wharton.
Less to invest – “The easiest way to distill the decision down is to think of it in terms of opportunity cost,” Roberts said.
Ask yourself this question: Is the interest on my mortgage greater than what I can earn from saving or investing this money?
Loss of mortgage interest deduction – If you itemize, you can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately). The limit is $1 million ($500,000 if married filing separately) if you are deducting mortgage interest for a home purchased before Dec. 16, 2017.
Even if you take the deduction for mortgage interest, don’t overestimate its value. This tax break is a deduction, not a credit. A tax credit reduces, dollar for dollar, the taxes you owe. A deduction eliminates only a percentage of your income subject to taxation. The 2017 Tax Cuts and Jobs Act nearly doubled the standard deduction, resulting in fewer taxpayers itemizing deductions on their tax returns.
Now let’s look at some positive reasons to pay off your mortgage early.
Better cash flow – The mortgage for most Americans is their biggest household expense. Getting rid of that obligation frees up a significant amount of cash every month. We already know, based on data from the Federal Reserve, that many households have trouble responding to a financial emergency without having to borrow money.
Sandy Marasco paid the $22,000 remaining balance of her mortgage with savings, which was costing her $1,200. She has a 401(k) but can get by on Social Security and a small pension.
“I finally decided to retire, and I wanted to get my monthly expenses down as much as possible,” she said. “I went through my younger years with too much debt. Something disastrous would have to happen for me not to have a place to live.”
Guaranteed return – One of the reasons people are often discouraged from paying off their home loans is that they are told they can earn more by investing in the stock market.
But this advice ignores risk, said Christine Benz, director of personal finance for Morningstar.
“If you’re retiring debt, you are getting a positive return equal to whatever that interest rate was on the debt, less any tax breaks you were getting for carrying it,” Benz said.
For young adult homeowners, they could reasonably outearn that interest rate by investing in the market, and they don’t necessarily need that peace of mind of paying off the mortgage, Benz said. But for people closing in on retirement, or who are retired and have other assets, paying off the mortgage could be a great move.
“One of the best things you can do for your plan is to reduce your fixed expenses coming into retirement,” Benz said. “Reduce the head wind of ongoing expenses and that will make you so much more flexible in the face of whatever might happen in your retirement, whether it’s big health care bills or a bad stock market.”
Roberts also acknowledged that the flip side of investing the money for a higher return is recognizing that past performance of the stock market does not guarantee future results.
“If you try to find an investment that guarantees you an income at the same rate of return, it will almost surely be lower than what you’re paying on your mortgage,” he said.
Peace of mind – “There’s sort of a big psychological burden that’s lifted,” Roberts said. “So having the overhang of debt payments constantly is psychologically important. And that might sound odd coming from an economist, but it’s precisely because I’m an economist that I can recognize the importance of psychological factors.”
If you have the money to pay off the mortgage and there’s not a liquidity issue, meaning you have enough in savings, then your financial peace of mind is a legitimate factor in this decision, Benz said.
One Maryland couple plans to retire their mortgage early in December. They are both retired and have more than adequate savings. Their mortgage wouldn’t have been paid off until 2043.
“Most people keep telling us, ‘You’re always going to owe something,’ ” the husband said. “Most people just don’t believe they can be debt-free. But I just keep remembering the loss of the mortgage payment will help us to save and give more.”
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