Is Time to Pay Off The Mortgage?

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Elaine Bedel established Bedel Financial in 1989 in Indianapolis. Elaine Bedel established Bedel Financial in 1989 in Indianapolis.

With uncertainty surrounding investment markets, homeowners with cash are questioning whether to pay off their mortgage or invest the extra dollars. The answer is... It depends!

Because no one can predict the returns that investors will receive over the next ten years, it is impossible to predict with certainty which strategy is better for a homeowner with extra cash. However, there are two ways to consider this question. One is purely financial and the other is based on your personal feelings regarding debt.

Financial Analysis: Mortgage Rate versus Potential Investment Return

If your mortgage interest rate is greater than the investment return that you can reasonably expect to earn, then apply the extra cash to your mortgage. If not, then over the long-term, it’s to your financial advantage to invest the cash and continue to make monthly mortgage payments.

For example, assume your mortgage interest rate is 3.75 percent. If your investment portfolio is allocated half to fixed income and half to the stock market, historical returns indicate a reasonable expected long-term return of 6 percent. As a result, it makes sense to retain your 3.75 percent mortgage and invest your cash. If you are intentionally investing on a conservative basis and the expected investment return of your portfolio is 3 percent to 4 percent , then paying off a 3.75 percent mortgage is appropriate.

Current Stock Market Environment

When evaluating your options, do not let the current stock market fluctuations keep you from making the appropriate decision. When the stock market is sluggish, many people choose not to invest for fear of losing money. However, a longer-term perspective is necessary. If the stock market is appropriate for your extra cash, investing during a market down cycle can potentially result in significant future growth for your portfolio.

Tax Benefits

If you itemize your deductions on Schedule A of your federal tax return, the mortgage interest you pay reduces your taxable income. You can deduct the interest costs for your main and/or a second home up to a maximum of $1,000,000 ($500,000 for married filing separately) in mortgage loans that are used to buy, construct, or improve the property. Home equity debt up to $100,000 ($50,000 married filing separately) can be deducted regardless of how you use the loan proceeds.

Therefore, if you pay off your mortgage early, you will lose this itemized deduction.  The impact of the interest deduction is essentially lowering your mortgage rate. In our example, the net effective mortgage interest rate may be reduced from 3.75 percent to 2.8 percent, depending on your marginal tax rate.

High-income earners beware: There is phase-out that reduces the amount of total Schedule A itemized deductions you can take. If your 2016 adjusted gross income is above $311,300 for joint filers ($259,400 for singles) this may apply to you.

Personal Comfort: Desire to be Mortgage-Free

Your personal comfort with debt is as important as the aforementioned financial analysis. If you are by nature risk-adverse, then paying down your mortgage may be the best option regardless of the mortgage rate. For some homeowners, there is a feeling of security and comfort in being mortgage free, especially at the time of retirement. If being debt free makes you sleep better at night; then pay off the mortgage.

Summary

If you have extra cash and a mortgage, analyze the financial and personal consequences of having the debt. However, there may be other factors that should be involved in your decision making as well, such as cash flow issues, saving goals, and other debts besides your mortgage. It is important to review your personal financial plan to ensure your decision supports your overall goals. 

This article was contributed by Meredith Carbrey, CFP, a Wealth Advisor at Bedel Financial Consulting, Inc.

Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, "Your Money" segment.  Elaine's book, "Advice You Never Asked For... But wished you had," is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at ebedel@bedelfinancial.com.

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