“What should I do with my mortgage?” Every homeowner has asked this question, and for good reason. For many, their home is their largest financial asset. And, since most can’t afford to purchase their dream home outright, many take out a mortgage.
Opinions vary widely on what to do with mortgages. Some long to be “free and clear” and not owe anything to anyone else, especially a mortgage firm. Others, however, are comfortable with leverage and want to invest elsewhere in their stock portfolio, business, or children’s education. Not even professionals agree. The internet, evening news, and bookstores are filled with financial “experts” passionately defending both sides.
How, then, can a homeowner decide what’s best in his or her situation? Here are some major considerations when making this important and personal decision.
Why keep that mortgage on the books
Snag that interest deduction
If you itemize deductions, you can take advantage of the home mortgage interest deduction. For those borrowing after 1987, you can deduct interest on home acquisition debt of up to $1 million and home equity debt of up to $100,000 .
This is especially significant for investors in a high tax bracket, many of whom already itemize. This deduction can be another valuable tool in lowering your tax bill to Uncle Sam.
This deduction is most important early on. During the first few years of a fixed mortgage, most of your payment goes to interest, resulting in a larger tax deduction. How much you can deduct drops over time as more of your payments are used on non-deductible principal instead of interest.
Diversify your portfolio
Keeping your mortgage allows you to invest more in other areas, such as stocks or bonds, and diversify your net worth. If paying off your mortgage means a significant percentage of your assets is tied up in your home, you might be under-diversified. As a result, if real estate tanks, so does your portfolio.
On the other hand, homeowners comfortable with risk may benefit by investing more elsewhere. By keeping their mortgage, they are essentially borrowing at a fairly low rate (perhaps 4-5%) to earn more diversified returns in stocks and bonds. This strategy works best for homeowners with a longer investment horizon, such as young couples in their 20’s or 30’s.
Note that this strategy does entail more risk. During the most recent stock crash, the S&P 500 lost 56% between the high in October 2007 and the low in March 2009 . While you can’t guarantee stock returns, you can be sure your mortgage company will want their payment month after month, regardless of what the market does.
Address other areas of your financial plan
Investors may consider keeping their mortgage to focus on other areas of their financial health. Here are some questions to ask yourself:
- Do you have adequate savings for retirement?
- Are you planning to help with a child or grandchild’s college education, and have you already set aside enough funds?
- Do you have any big expenses planned for the near future, such as starting a business or purchasing a rental or vacation home?
- Do you hold other debt with a higher interest rate, such as credit card or student loan debt? If you have the funds to cut back on what you owe, start with the most costly debt first.
Why burn that mortgage once and for all
Gain peace of mind
Many people prefer the freedom of owning outright. If the housing market turns south, you aren’t stuck owing more than you own. And, if you lose your job or have unpredictable income, you can breathe easier without a mortgage company on your back.
This can also benefit your family. If the primary breadwinner passes away before the mortgage is paid off, other family members may be left scrambling to meet the monthly payments. Homeowners concerned about this risk can also consider life insurance. One type, decreasing term insurance, is designed to cover a homeowner’s mortgage. The benefit drops over time to match the lowering principal balance.
Earn a specific return
When you pay off your mortgage, you are essentially earning a specific rate of return. For example, if you have a 4% interest rate, you save that 4% over time by paying the full balance now instead of later. Certain returns are hard to come across in the financial world. If you can earn a specific return without jeopardizing other areas of your financial plan, why hold back?
Is it better to own your home free and clear, or keep your debt indefinitely? This is a highly personal question. Homeowners must consider all relevant factors in their financial pictures. Moreover, there is no “right” decision; at the end of the day, your own personal comfort is the largest part of the equation.
Younger homeowners with limited assets, especially with big expenses looming in the near future, may want to keep their mortgages for now. Higher income individuals early into their mortgages may also wish to stay put for tax benefits and scoring more diversified returns elsewhere.
On the other hand, homeowners not as comfortable with debt or with unpredictable incomes may want to pay off part or all of their mortgages now. Likewise, retirees may want to “retire” their mortgages to eliminate one last lingering obligation and enjoy more financial freedom.
Also, homeowners should only consider paying off their mortgages if doing so won’t impact their lifestyles. If you don’t have emergency savings in the bank or are going through a rough patch in your career, place first priority on your other financial needs. Your mortgage can wait.
Still have questions?
Still unsure about what’s right for you? We’d love to help you better understand your personal financial picture and reach the best decision. Contact our office today to learn more.