Hey guys, Mike Frontera here back with another edition of Retirement Theory!
Ah the American Dream of home ownership! You finally have your piece of the pie-- with a paid off mortgage being the cherry on top, of course! It’s a huge priority for so many people, especially late in their careers. Having that mortgage payment drop off your expense list can be a huge help to your cash flow. Not to mention all the interest you save. It’s a psychological boost too, knowing that the world could crumble (within reason) but you still have a roof over your head. It’s like that last payment coupon is practically your permission slip to retire.
There are very few good arguments (though some exist) against paying off your mortgage over time. But what about accelerating those payments to pay it off faster than scheduled? Or knocking it out entirely with a lump sum payment? Is that always smart? Not always. So before you hurry to pay off your mortgage, slow down and consider the following points.
Well, the first thing to keep in mind when you take a lump sum of cash to pay off your home, is you lose use and control of that money. Whether you have money from maybe the sale of an old house or you've got money socked away in savings, that money can be used for anything you want- or need. But once you decide to pay off your mortgage with that money it becomes a lot harder to get that money back out to use it for something else.
And, as you know, stuff invariable does come up. So if after paying off your mortgage you don’t still have a very ample emergency fund (6 months of expenses or more if you’re retired), it may not be worth doing. Think of what else that cash may be needed for. Home improvements, medical expenses, a new car, student loans for your children, or other loans that you’re paying a higher rate of interest on.
If you’re not retired yet, are you putting money away in a 401(k)? You generally don’t want to forgo funding your retirement in order to pay down your mortgage faster. Especially if your employer offers a match on your 401(k). Giving up a match so you have more money to put down on your mortgage is almost always a bad idea. So make sure that you’re that properly funding your retirement before you aggressively wipe out your mortgage.
Well maybe you’re retired, and you have enough cash to pay off your house but all of your other money is in 401(k) or is in IRA accounts. If that cash is suddenly gone, it might cause you to have to pull all your future income needs from those retirement accounts. If it does, you may find yourself in a higher tax bracket, paying much more in taxes than you were ever paying before in interest.
There's a lesser known issue that comes from paying off a mortgage too. If you plunk down a large sum of cash to pay off your home, you’re effectively changing the composition of your investment portfolio. How so? Well, you’re now much more heavily invested in real estate and the price direction of your home will have far more sway on your overall net worth. How might it impact you for example, if your house goes down in value? Or worse, what if your home suddenly has major termite damage, or water damage or some other serious problem that isn't covered by your insurance? That’s your money at risk now, not the bank’s. Clearly there are a lot of outside factors that you must think about before you pay off your home. But forget those for a moment.
Just pure dollars and cents, is it smarter to invest your money rather than pay off your house? Maybe not. First, with mortgage rates on the rise it’s becoming a higher and higher hurdle to clear to make investing the cash a more profitable endeavor. Remember that the interest that is paid to the bank is in a sense a guaranteed rate of return if you can eliminate it. Whereas investing the funds almost always carries some sort of risk. If you invest your funds poorly and lose your money, you still have to make your mortgage payments. So desire for long-term potential profit in of itself is usually not a good enough reason to invest a lump sum of cash rather than to pay off a mortgage with it. If you are thinking along these lines, try looking at it the other way around. That is, if you didn’t have a mortgage on your house, would you take one out strictly to invest the proceeds? Most people probably wouldn't do that.
So…do you have questions? Let me know. Give me a call at (518) 612-1060, or just visit me at www.retirementtheory.com . Do you follow me on Facebook? I think that you should. You'll see videos like these, and get blog and article shares on everything retirement planning. Once again, thanks for joining me. See you next time