At some point, most of our customers will ask whether paying off their mortgage or paying it down more aggressively is a wise financial decision. Like most financial decisions that are complex, the answer to this one depends. With the assistance of a professional financial advisor, you should consider several factors to decide if paying off your mortgage is advisable or utilizing your assets in other ways. This article is intended to answer the question of whether it makes sense to pay off your mortgage or use financial assets elsewhere.
Cash Flow Management
In order to determine if you should pay off your mortgage, it is important to examine your cash flow within the context of all your financial goals. After prioritizing your savings goals in relation to your overall financial objectives, you need to decide if there is excess cash flow. You can, for example:
- Have you set aside emergency funds?
- Do you participate in all 401(k), and do you make the most of them? The maximum contribution to a 401(k), in 2021 is set at $19,500. Individual retirement accounts (IRAs) are limited to $6,000 each.
- Do you currently have a strategy for saving money to fund your education, like a 529 College Savings Plan?
- Are you saving enough for other goals? Are you saving enough for other goals (i.e. vehicle purchase, vacations)?
Considerations for Debt
This debt should be paid off before paying down your mortgage because it typically has a higher interest rate and is not tax deductible. It is best to pay off this debt before you start paying down your home mortgage, as it usually has a high interest rate and cannot be deducted from taxes.
You will need to consider the tax-deductible nature of your other loans, such as a home equity loan (HELOC) or a car-loan. You might want to begin by paying off your car loan, as it’s not usually tax-deductible. Then, look into your HELOC which is either tax-deductible or not (see the sidebar for further information).
Risk Assessment
Consider the return and best way to use your money when deciding whether to pay off a mortgage or to invest extra cash. You need to compare the risks of the mortgage with the potential investment. You are technically better off investing if you compare the 30-year fixed-rate mortgage with the inflation adjusted average return on the stock market. The current rate is about 4%. The decision may not be as clear-cut. Markets are not “average” and you can’t predict the future return of your investment. Your risk tolerance and investment time frame, as well as other factors, should be considered. Ask yourself the following questions.
- How much risk are you willing to take? Paying down the mortgage makes sense if your investment returns (plus any interest) will be less or equal than your mortgage. You will pay less in interest the more you reduce your mortgage.
- How long do you plan to invest? Your investment time-horizon is important because it goes hand-in hand with risk tolerance. Are you invested for a long time enough to withstand a possible market decline? A person with a high risk tolerance who is looking to invest over a long period of time may feel more comfortable than someone planning to retire within the next two years.
- For how long do you plan to stay at the home? Paying down your mortgage or paying it off makes sense if your home is your forever home, where you will be living for many years.
- Are you underwater with your mortgage? While most home owners expect their house to appreciate in value over time, there are some who find themselves this situation. You’re better off paying off your mortgage if you can.
Mental Considerations
It’s important to remember that, as with most financial decisions it is not all about numbers. Some people, particularly those who are nearing retirement age, find the idea of having to pay a mortgage stressful. Some homeowners can’t bear the thought of having to pay a mortgage in retirement, even if they are able to afford it. They would probably have been better investing any excess funds. Younger people have also expressed a feeling of freedom and accomplishment when their mortgage is paid. Often, the decision which helps you to sleep well at night will be your best choice.
The conclusion of the article is:
We encourage you to follow these steps and speak to a financial adviser to make sure you are considering your unique financial situation and personal goals when making a decision. It’s possible that the decision you make is not right for you.
