In 2019, I paid the balance on my home mortgage, which had only a 3% interest rate. I like to think of myself as a financially sophisticated person and I realize that paying-off a loan with a historically low interest rate is not what many financial experts recommend. So why did I decide to pay-off my mortgage with excess funds in 2019?
The General Rule
Most financial planners will base a decision on whether to pay-off your mortgage early by comparing your expected rate of return for your investments against your mortgage’s interest rate.
In today’s environment, if you perform this analysis using a current mortgage interest rate of 3.5%-4.0% on a 30 year loan, and compare it to an investment return of 7% or more, it seems most logical to use your savings to aggressively invest and pay the minimum on your mortgage in order to take advantage of today’s low interest rates.
I followed this approach for most of my investing life. I would try to make sure I had the lowest available mortgage interest rate, pay the required monthly mortgage payment, and place my available savings into different investments. I believe this approach is generally the correct approach. But not always. Here are some of the reasons I recently decided to pay-off my mortgage.
Reasons You Might Want to Pay-Off Your Home Mortgage Early
There are a few reasons why you may want to use your savings to pay-off your mortgage early:
The Emotional Benefit to Paying-Down Your Mortgage is Real
If you think about quitting your job at some point after achieving financial independence and get a queasy feeling in your stomach because you will still have significant monthly expenses then you might want to see if you can get more comfortable with the idea of trading in that paycheck for financial freedom if you eliminate that monthly mortgage payment. You can include this as one of your milestones to achieve before declaring financial independence. You can decide to pay-down your mortgage monthly or wait and at a later point take some of your investments and pay-off the mortgage. By doing the latter you can put that money to work in investments until you decide it is a good time to pay-off your mortgage.
I can say with confidence that it feels really good to sleep in a home that I own free-and-clear. One reason I sleep well at night is because the home my family wants to live in until my kids go to college does not have a mortgage. It still costs money to own this home – see my post on how much it costs – but the biggest risk to losing or having to sell my home (an unpaid mortgage and it’s monthly payment) has been removed from the equation.
No Tax Benefit
In 2017, the standard deduction nearly doubled to $12,000 for single filers and $24,000 for married couples filing jointly. In addition, there are new limits in home mortgage interest deductions and the use of state and local taxes as deductions. The combination of these changes to the tax code may reduce the benefit you receive from your mortgage interest as a tax deduction. I noticed that in 2018, my accountant used the standard deduction for my tax returns. Therefore, I did not use my home’s mortgage interest as a tax deduction (meaning I received no tax benefit from paying the interest on my mortgage). If you are the person that always says “I like the tax benefit from having a mortgage so I do not want to pay it down early,” you should determine whether you still receive that benefit.
If you already have a healthy investment portfolio of stocks, you may want to consider paying-down your mortgage as a form of diversification. Think about it – even financially sophisticated people will invest part of their money in treasuries that yield less than 2% as a form of diversifying their investments with very safe assets. Investors are often willing to accept lower returns on some of their investments to reduce volatility in their portfolio. If you pay-down/pay-off your mortgage, you are locking in a return (the interest rate on the mortgage) and/or investing in real property (which will likely appreciate over time) and by doing so you are diversifying your investments.
I paid-off my mortgage to reduce my market risk, invest in the appreciating real estate market in California, and dramatically lower my monthly expenses by no longer having a monthly mortgage payment.
I also decided to pay-off my mortgage at this time because the S&P 500 Index has reached all-time highs after 10+ years of growth. Markets cannot continue to go to the moon without eventually suffering a correction. Stock market corrections can happen pretty quickly and the markets can take years to recover – I wanted to reduce my exposure to getting caught in the middle of a correction and use some of my hard-earned savings to pay-off the debt against one of my assets.
The 65 year old who is retiring may want to avoid having a large monthly expense hanging over his/her head in his/her golden years. In this case, people getting close to a traditional retirement pay-off their mortgage to lock-in reduced monthly expenses. Retirees generally want greater certainty across their investment portfolio and so they are more willing to accept lower rates of return in exchange for reduced volatility. They cannot afford a lot of volatility to their investments because they need the certainty of fixed income and reduced expenses. Today, people that achieve financial independence are often younger than the traditional retirement age but the same principal of certainty applies and should be considered when evaluating whether to pay-off your mortgage early. When I stopped working in March 2019, I declared financial independence but I also let go of that nice monthly paycheck. I wanted some greater certainty with my financial picture before I stopped working so I reduced my fixed expenses by paying-off my mortgage. I accepted the potential of a lower rate of return for this part of my savings.