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Dear Quentin,
I currently owe $300,000 on my house with a 2.5%, 30-year mortgage. I am maxing out my retirement accounts — IRA and 401(k) — and looking to retire in less than 10 years. I will receive an inheritance of at least $300,000, so I will be able to pay off the house.
I’m in a very lucky position. Should I pay it off — or should I invest the money?
Homeowner
Dear Homeowner,
You will save a considerable amount of interest by paying off your mortgage early, especially at a 2.5% rate. Millions of homeowners would kill for that rate.
Of course, a lot of it has to do with luck. Let’s take a moment: The 30-year mortgage rate is over 5.5% currently. The consumer price index rose 8.5% in July from a year earlier, and the closely watched “core” measure of inflation — excluding volatile food and energy — was hovering at 5.9%. With a 2.5% interest rate, you are already making money simply by living your life.
As my colleague Aarthi Swaminathan put it: “While the price of their car, gas, electricity, and other expenses go up, that homeowner will also see their home value rise with inflation. Yet their mortgage rate remains the same as it is not inflation adjusted, which means they’re still paying the same rate that they were pre-inflation.”
Overpay some if you can, especially early on in the lifetime of the loan when the interest-rate payments are higher. Depending on the terms of your mortgage, you may be limited on the amount in overpayments you can make (10% in some cases), and as galling as it seems, there may be a penalty for overpaying. In your case, that could actually be a good thing.
“With a 2.5% interest rate and inflation at 8.5%, you are already making money simply by living your life. ”
Your tax-advantaged retirement savings at, say, 6% will be doing a lot of the heavy lifting for you, offsetting your 2.5% interest rate, assuming that you have a healthy 401(k) and IRA. Talk to a financial adviser, and make sure that you would still have enough to live comfortably and pay down your mortgage and/or downsize.
Speaking of financial advisers, Larry Pon, a financial planner based in Redwood City, Calif., says many people who have extra money face your dilemma, and there is no right or wrong answer. He agrees with me: “I would do both. I would not pay off the mortgage and not invest the inheritance aggressively, but do a combination.”
“Since you are 10 years out from retirement, for the inheritance, I suggest investing with a moderate allocation, which is somewhere between 50/50 and 60/40 for stocks and bonds. This portfolio may generate enough income to increase your mortgage payments,” Pon said. “This means you may not notice any difference in your personal cash flow and pay off the loan in 10 years.”
Continue to max out those accounts. “I assume you are over 50, so you can put $7,000 into an IRA and $26,000 into your 401(k). I have been doing this for 36 years and I have yet to meet someone who put away too much for retirement,” Pon added. “I strongly suggest you continue to max out your retirement plans so your retirement will be more secure.”
Pon outlines the pros/cons of investing and paying off the mortgage. Here are his pros: 1. No more mortgage payments. 2. Paying off debt is a risk-free investment. “You will be saving at least $1,200 a month, which means instead of paying the mortgage, you can redirect your payment amount into your savings.” 3. “This will make your retirement more secure.”
And the cons: 1. Your mortgage rate will probably never get this low again. 2. If you invest the $300,000 instead of paying off the mortgage, you will be assuming investment risk. 3. “Even in the current market, it is expected your investment returns will be more than 2.5%. This is not risk free or guaranteed, but taking some risk will give you a greater return.”
If it were me? I’d pay off the loan. I don’t like debt. We spend the first part of our lives desperate to get a mortgage, and then the rest worrying about paying it off. They are a necessary, if sometimes unhealthy, obsession. Mortgages give us something to focus on aside from the other “M” word: our mortality.
Still, life would be sweet with a mortgage paid off. Until that next obsession comes along.
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