With the markets being extremely volatile and confidence at an all time low, I am getting a lot of questions from clients about whether or not to pay off a mortgage. Interestingly, if you had asked the same question five years ago, my answer would have been different.
On the one hand, with interest rates at an all time low, it makes total sense to have mortgage debt. Most homeowners’ interest rate on their home loan is between four and five-and-a-half percent. Once you take the tax deduction, it brings the real cost of borrowing to just above three percent. That is incredible.
But this question has become a little more difficult to answer from a more holistic viewpoint. There are many more things to consider. [See Unemployment: Cause or Symptom?]
First of all, borrowers are looking at the alternatives to paying off their mortgage. They can put the money into the bank, which is paying virtually nothing. They can put it into the stock market, which often seems to be going down. Frequently, people are choosing to put it into their home, because if their home is paid off, nobody can take that away from them. While over the last few years home values have gone down, it’s still a roof over your head. That roof provides shelter, one of the most basic of needs as outlined by Maslow.
Second is cash flow. For most Americans, their biggest expense is their mortgage payment. If they could eliminate that expense, getting a pay cut or losing their job would have less of an impact. Also, going into retirement without a mortgage would be the crème de la crème of retirement. Imagine retiring without debt. In that scenario, everything you make could go towards your basic needs and towards enjoying your retirement years. It sounds pretty good to me.
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Third is the issue of home value in retirement. Many people downsize when they retire. When they do, having a paid-off home can provide the money needed to purchase a smaller home with some excess that can be used for retirement expenses. Also, if in retirement you run out of money, that paid-off real estate could potentially give you ample assets through a reverse mortgage. While it is not the best situation to be in, it is great to have the option.
Knowing now that it may make sense to pay off that large real estate loan, the question is how do you do it?
A rule of thumb with a 30-year fixed-rate mortgage is paying one extra payment per year, which will take seven years off of your term. That should be your first step.
The next is to think about your mortgage each time you get a raise. Because you did not need that extra income before, you probably could still do without it and can put it towards your home loan.
Also, every time rates go down, you should consider refinancing. Another rule of thumb is that if you can lower your interest rate by at least one percentage point, it pays to refinance. In addition, many mortgage companies are refinancing notes without expense.
Finally, look at 15-year loans. They currently are charging less than the 30-year alternative.
Initially, it may not seem to make sense, but when you consider your personal situation, paying off your biggest debt may be your best financial decision. Good luck and happy investing.
Kelly Campbell, CFP® and Accredited Investment Fiduciary, is founder of Campbell Wealth Management, a Registered Investment Advisor in Alexandria, Va. Campbell is also the author of Fire Your Broker , a controversial look at the broker industry written as an empathetic response to the trials and tribulations many investors have faced as the stock market cratered and their advisers abandoned their responsibilities to help them weather the storm.