Is paying off your mortgage right for you?

Karen Mayfield
Posted by Karen Mayfield
Mortgage Banking

In my parents’ generation mortgage-burning parties were, if not common, at least an aspiration of many homeowners. Part of the American Dream was to pay off that 30-year fixed-rate mortgage and celebrate with family and friends.

Front view of brownish house with small front yard, blue sky in background.Today, many of us move several times during our careers or refinance our mortgage multiple times, and so paying off the mortgage is less of a priority. And the truth is there are pros and cons to paying off your mortgage.

About 30% of American homeowners own their home outright, according to research released early last year by Zillow. Many of those owners are retired. The survey found, for example, that 41% of homeowners ages 65-74 own their homes outright compared to 20% of homeowners ages 50-54 years of age.

The big advantage to paying off a mortgage is you no longer have the monthly payment, which may be your largest monthly financial obligation. Understandably, many people want to be free of a mortgage payment once they are retired. But the decision to pay off the mortgage is not always simple.

Let’s take, for example, a $300,000, 30-year, fixed-rate mortgage with a rate of 5%. Your fully amortizing monthly payment will be $1,610. If you have the $300,000 in cash, you could save that $1,610 monthly payment. But, you should weigh the pros and cons.

1) Liquidity: Managing finances for most of us is a balancing act between keeping our debt as low as possible while maintaining a cushion of cash to live comfortably and be able to cover unexpected bills or vacation opportunities that pop up. Many people, for example, use credit cards all month long to avoid draining their checking account, and when payday comes they completely pay off the balances and avoid interest charges that come with maintaining outstanding balances.

A mortgage is similar but on a bigger scale. If you have $300,000 in cash, you have to ask yourself: Do you want to tie up all that money in your house? Maybe you do, particularly if you still are left with a cash cushion. One way to think about it is that if you have a monthly payment of $1,610 on a $300,000 mortgage and you have $300,000 in a savings account, that cash could cover mortgage payments for 186 months — that’s more than 15 years.

2) Tax benefit: In most cases mortgage interest on a primary residence is tax-deductible, but I always recommend people consult a tax expert about their own situation. In the early years of that $300,000 mortgage, around $700 of a payment will be interest, which amounts to a roughly $8400 deduction on federal taxes.

3) Interest rate comparisons: Before you decide to pay off your home loan, compare the interest rate on your mortgage to rates you are paying on other debt, such as an auto loan or a student loan. Typically, you want to pay off debt with higher interest rates.

More sophisticated homeowners and investors tend to look at both the interest rate they pay on a mortgage and the potential returns they expect on investments to decide what to do with $300,000. If they pay off that 5% fixed-rate mortgage they will save $15,000 a year in interest. If they believe they can earn more than 5% by investing $300,000, then they might choose to do that rather than pay off the mortgage. Of course please consult an investment professional to determine the best course of action for your financial situation.

4) If you do it. If you plan to pay off your mortgage to help you live on a smaller income that you foresee on the horizon, consider establishing a home equity line of credit now as part of your security blanket. If you foresee a reduction in your income, remember that any future application for credit will be based on your new income stream.

Lenders typically charge an annual fee of less than $100 for maintaining a home equity line of credit, even if there is a zero balance. But I really think that minimal cost is worth it to have easy access to a credit line.

Everyone’s financial picture and needs are different. Paying off a mortgage can be a big decision so you need look at all the angles. It’s not as simple as just eliminating the monthly payment.

As for those mortgage-burning parties? I came across a light piece on NPR from a few years ago about whatever came of those.

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Want to learn more? You can use the Bank of the West site to find a local mortgage banker and check rates.

 

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