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Dear MarketWatch,
I am considering paying off my mortgage. I am 60 years old and have a $250,000 mortgage on my home. The home is worth $950,000. The mortgage payment is $2,800 a month on a 30-year loan. The interest rate is 3.875%, and I have 24 years left on the loan.
I live in a high tax state. Taxes are $1,200 per month. The home is in good shape and needs no major repairs. I plan to work until I am 67. I will have a pension of $8,000 per month. I now have $1 million in my 401(k) and $1 million in company stock. I will have to sell stock to pay off the house.
Should I pay off the mortgage now, or wait until I retire after 67?
Thanks,
Waiting to pay
Dear Waiting,
“Should I pay off my mortgage in full?” is one of those all-time, classic questions up there with “Who’s on first?” and “Wherefore art thou Romeo?”
I say this not to poke fun at you or your situation, but to drive home how common a question this is. Indeed, you’re not the only reader who has written me recently asking some variation of this query. I polled financial planners to get their take on this age-old quandary, and time and again they told me that they have clients dealing with this very issue, especially as they’re staring down retirement.
The common wisdom with previous generations was to avoid retiring with any debt. But boy, have the times changed. “Historically, it was taboo to go into retirement with debt, but that made sense when you had mortgages with rates upwards of 7% or 14%,” said Marianela Collado, CEO and senior wealth advisor with Tobias Financial Advisors, a wealth management firm based in South Florida.
We don’t live in a world with interest rates that high. Even though your mortgage rate isn’t below 3% — where the average rate on a 30-year fixed-rate mortgage now sits — it’s practically chump change compared to a few decades ago.
When deciding whether to pay off your mortgage ahead of schedule, it’s important to go about the decision as rationally as possible. There is almost certainly going to be an emotional benefit to ridding yourself of such a large monthly payment and not having a debt obligation to worry about. But it’s not necessarily the most financially prudent route.
Like many people considering this move, you’re thinking of dipping into your investments and savings to do so. If the stocks you’re invested in are performing anywhere close to the S&P 500
SPX,
they’re netting a return of 10% a year on average most likely — if not better.
Here’s where you need to consider the opportunity costs of this move. If you pay off that $250,000, you’ll save upwards of $100,000 in interest, not accounting for any prepayment penalty you might incur. But you’d be missing out on a potential return as high as $1.7 million, presuming a 10% rate of return, on the investments you would cash out to pay off the mortgage.
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Using savings to pay off a mortgage ahead of schedule could mean forgoing thousands of dollars in earning potential.
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Plus once you’ve sunk that money into your home, you can’t use it for other potential needs without taking out a line of credit or reverse mortgage or selling the home.
“With interest rates so low, paying a mortgage with a low rate means more of your capital can be freed up to invest,” said Bradley Lineberger, president of Seaside Wealth Management in Carlsbad, Calif. “A solid investment portfolio should easily outpace whatever the interest rate savings would be by paying off the note.”
Of course, the answer is different if cash flow is currently an issue, or if you expect it to be one in retirement. Because you have a pension you can count on, that might not be the case. But if you find yourself scrimping each month after your mortgage payment is made — or if you’re worried about your ability to make ends meet in retirement — you may want to consider using your investments to pay the loan off. Doing this would allow you to live more comfortably with a lower fixed income, if need be.
I should add that in reality your situation isn’t an either-or question. You have more options at your disposal than simply paying the loan off in full or maintaining the status quo.
Given that your current rate is higher than the prevailing rates in the market right now, you may even want to consider refinancing your mortgage. You could potentially refinance into a mortgage with a shorter term, such as a 15-year loan, without increasing your monthly payment. This way, you’d save on interest and pay off the loan more quickly.
You could also pursue a mortgage recast if your lender or servicer allows it. With a mortgage recast, a homeowner makes a large lump-sum payment toward their loan’s principal balance. After doing so, the lender recalculates the amortization of the loan. So your monthly payment would be lower, though the interest rate and duration of the loan would be the same.
Recasting a mortgage is less expensive than a refinance and doesn’t require a credit check or appraisal. Be aware though that the lender may charge a fee to do this, and not all homeowners qualify. If it is an option available to you, though, it might be a great way of finding a middle path between the options you are considering.
