For most of us, our mortgage is by far the largest debt we hold, equating to a significant portion of our income. Can you imagine no longer having to write that hefty check each and every month? That thought begs the question: Is it worth paying down or paying off your mortgage to eliminate this debt sooner versus later?
Here are a few things to consider before making this decision.
- Do you have other high interest debt?
In general, steering clear of debt is a good thing, with the exception of a mortgage. Mortgages are actually considered ‘good personal debt’ because of the low interest rates and ability to use your loan as a tax deduction. The majority of other debt, the main one being credit cards, is deemed ‘bad debt’.
Also, most homes are an investment and tend to appreciate in value while pretty much everything else we purchase on credit loses value the moment we acquire it. So, by the time we pay off a credit card with 14% interest, the television, computer, clothing or other item has depreciated considerably while when all is said or done, you’ve paid a substantial amount more than its original worth.
- Do you have an emergency fund?
Having 3 to 6 months of liquid cash in a nonvolatile, safe location such as a savings account is a sound economic move that can help quell any financial strain that might arise during a job loss or other unplanned emergency. It is unwise to rely on an equity line of credit as an emergency fund as HELOCs can be frozen or cancelled at any time. If you don’t have a robust monetary reserve in place, you’re better off seeding your emergency fund rather than trying to pay down your home loan.
- Are you maximizing your 401K or other retirement fund?
If you work for a company that matches your retirement account contributions, be sure to take advantage of this free money by maximizing the amount you pay into your accounts as much as you are able. Paying yourself via funding your retirement accounts benefits you come tax time and usually gives you a much higher return on investment than would paying down your mortgage.
- How much would you save?
With interest rates at historic lows coupled with the fact that mortgage interest is deductible, the majority of home owners won’t save much if they pay off or pay down their loan. For example, if you have a 4% interest rate and fall into the 25% tax bracket, your mortgage interest is more like 3% when you apply the tax breaks.
If you have a high APR, it is most likely worth refinancing rather than paying down your mortgage if you qualify to do so.
- Are you nearing or in retirement?
This is the one factor that can really make a pay off worthwhile. The longer you’ve had your mortgage, the less interest there is to write off. Also, if you are retired, you are not longer eligible to contribute to a 401K or an IRA and you may very well be withdrawing from those accounts.
If you fall into this category, paying off your mortgage could make financial sense. Do keep in mind that spacing out retirement account withdrawals over time reduces your tax bracket (i.e. if you withdraw $150,000 in a year, your tax bracket will be higher than if you withdraw $150,000 over two or three years. If you have 5 years remaining on your mortgage, make a determination if paying it off makes more sense than refinancing it with a 5 or 7 year ARM. Be sure to take into account the points and fees of refinancing.
As a rule of thumb, a home loan works to the financial advantage of most home owners by being a significant tax deduction, thus lowering our tax bracket. This ‘good debt’ is worth keeping while we add to our retirement and emergency funds and pay down other high-interest debt. As always, every person’s situation is unique and we always recommend you consult with a trusted financial advisor before making any major decisions.