“If I have the cash should I pay my mortgage off early?”
That is a regular question we are asked.
While it might seem to be the simple answer of “yes,” such is not always the case. Like anything, when it comes to making decisions for an individual, or family, a plan and some sound advice is always beneficial when facing these tough decisions.
Since we can’t do a plan, here’s some advice.
Everyone’s scenario is different and I do mean everyone. You may be able to pay your mortgage off and still have millions in the bank. Maybe you have enough guaranteed income and additional savings that paying the house off earlier won’t cause you to skip a beat. Or maybe you need all additional liquidity, flexibility and income you can get.
Regardless of your scenario, I believe everyone can take something from these 7 considerations.
Let’s set the record straight. I’m not opposed to paying your home off early when given the right scenario. In fact, there are times that paying your home off early can provide great peace of mind. First, I would go through this exercise:
1) Have a sounding board- No, not your neighbor
This should be your advisor, CPA and/or attorney. If you were my client, I’d prefer it be me. We’d build a team of professionals or work with your existing accountants and attorneys. Your team should be constructed of a group of individuals that have your best interest at heart, a fiduciary is a good start.
The only reason it shouldn’t be your neighbor is they generally have a biased opinion based on what they did. For every one good piece of advice I’ve heard a client gleam from a neighbor there are 9 bad ones.
I’m sure your neighbor is a great guy, extremely smart and successful, but odds are they don’t know your full financial situation. It’s not that your neighbor isn’t smart or even that it’s bad advice, it’s just that it’s not good advice for you.
Gathering information from a number of people may be helpful for you to digest the magnitude of such a decision. Remember to take that advice with a grain of salt and don’t get paralysis by analysis. Sometimes too many differing opinions can cause us to shut down or put decisions on the back burner.
Unfortunately, there are times we find out clients have paid their home off early after the fact.
For most, paying your home off early is more of an emotional decision than a planning decision. We need to reverse this aspect, just like when investing in markets we need to be as my partner Lance Roberts says “void of emotion.”
This is why it’s important to have someone on the outside looking in. Someone who has seen the triumphs, trials and tribulations of others, experiences that are sometimes priceless and can evaluate your scenario holistically.
2) How long do you plan to live in your home?
The amount of time you plan on living in your home could alter the decision to put your mortgage to bed.
Less than 5 years?
Keep your hard-earned cash on hand. Housing markets, like stock markets move in cycles. I’d hate to have to move and not have the necessary liquidity to put down on a new home or have to sell in a down or slow market.
Maybe you pay it off? I end that last sentence with a question mark, because this time frame is a bit trickier.
If you find yourself in position to pay your home off early I would hope you could weather any recessionary period even after making that last home payment.
You must have enough in emergency funds and not pull from other assets that are designated to other goals. If you lost your job tomorrow could you still pay your bills and for how long?
This now becomes a best use of capital question. How much interest are you paying and how much can you earn in a relatively safe investment. In today’s environment taking advantage of lower borrowing rates doesn’t seem like such a bad idea.
This is your “forever home.”
Meaning you plan to stay there until you can no longer care for yourself. I really have a hard time with changing your liquid asset (cash) and turning it into a hard asset (your home.) As my partner, Richard Rosso calls it “turning water into ice” I think the analogy fits considering you’re taking your hard-earned cash and putting it into something that’s difficult to “chip” away at. Rule 6 can also play a role in this decision, sometimes when you need senior care you don’t have the luxury of funding it once your home sells.
There is always an exception to the rule, in this instance it’s if the money is going to burn a hole in your pocket. Pay it off, lower your expenses and at least you will have put the cash into something worthwhile, your home.
3) Tax Deductibility
Itemize your taxes? If you itemize many consider the interest tax deduction as the “end all be all” when considering paying off your home. The truth is the majority of people that are paying off their homes typically are in the last years of payments and have little interest to write off.
When considering the deduction of interest one must remember that it’s not 1 for 1. What do I mean by that? The deduction doesn’t reduce your tax burden 1 for 1, it reduces your adjusted gross income by the amount of deductible interest or overall deductions.
Your Adjusted Gross Income (AGI) is: $100,000
Itemized Deductions are: $15,000
Taxable Income: $85,000
Yes, it does reduce your taxes. No, it’s not the reduction most think.
4) Best use of funds
What are the best use of funds? With current interest rates still near all-time lows, it would suit most to borrow money and use your cash in another way to get more bang for your buck. For most people leverage and credit is not your friend, however when used properly it’s a great tool.
Can you make more on your money investing semi conservatively? For instance, we can currently find investment grade bonds with a coupon of 5% with a 5-7 year duration, buying them at a bit of a premium you may see a 3-4% YTM return on your money.
The other argument is if you do pay your home off early and you’re in retirement the amount needed for expenses will decrease which will in turn decrease the amount you will need to pull from your investment accounts to live.
If you’re in the accumulation (working) mode paying off the home early would increase the amount you could put aside monthly.
Enter, the 5th consideration, liquidity.
How much is liquidity worth to you? Having liquidity gives you options.
It’s likely you don’t fall into this category since you’re still reading and considering options. Congrats, you’re in an enviable situation to the majority of your peers. The liquidity you possess is powerful.
According to a Bankrate study 69% of Americans don’t have enough saved to meet 6 months of expenses.
When disaster strikes or opportunity knocks I don’t know about you, but I want cash in hand or liquid assets.
Natural disaster, take Hurricane Harvey and all the Houstonians (roughly 70-80%) without flood insurance. There are some very tough decisions to be made by many, but in the end cash is certainly king.
Business opportunity or real estate deal you can’t pass up?
Need to move quickly, medical or family emergency or would just like to generate additional cash flow?
Cash flow is an important part of the equation. Can these funds generate some type of income for you and your family and you still retain a degree of flexibility? Go back to #4, best use of funds.
6) Do you have Disability or LTC Insurance?
While in your working years disability insurance is a must. If you use a substantial portion of your liquid assets to pay your home off it could be even more important.
How will you maintain the lifestyle your family is accustomed to if something were to happen such as a car accident or a health scare that kept you or your spouse from working for an extended period of time? A large part of financial planning is the risk management of protecting your family. Make sure you’re protecting your most precious asset.
Long term care insurance, do you, have it? Can you get it? Can you afford it without disrupting your cash flow? Do you need it? I could write a whole article on just these topics, but this should certainly be a consideration when paying off your home.
Remember, in your retirement years getting access to funds can be extremely important and when the funds are tied up in a home, access is limited and can take time.
If you do pay your home off early in retirement, having a home equity line of credit ready and available to use may mitigate some of that risk. I would also recommend having a Power of Attorney who can help in the event you’re incapacitated.
7) But my house has gone up so much in value!
For starters, if you have been in your home for any period of time I’d hope that to be the case. You’ve been socking money away in the form of your monthly payment year after year now add a little inflationary growth and I think you get my point.
Have you ever stopped to calculate how much you’ve actually put into your home in maintenance and improvements? And don’t forget to add those pesky property taxes and HOA fee’s.
Most find that after a similar exercise they come to realize that maybe their home isn’t the investment they thought it was.
The following two charts show prices in real terms and the percentage change.
Price in real terms indicate prices in $’000 at 2015 prices (deflated by CPI) and the percentage change shows the change in inflation adjusted prices between the two selected dates of 1980 to Q2 of 2016
These charts indicate that if you weren’t living in New York, San Francisco, Los Angeles, Miami, Boston or a handful of other offshoots the average American or Houstonian for that matter didn’t see substantial or real growth in their home valuations.
Unless you’re finding a home in foreclosure, at a heck of a discount or buying in one of the above valley’s I suspect that if we were as diligent about funding our other goals we may have a different outlook on what’s really our best investment.
Another consideration if you’re truly treating your home like an investment is you must actually sell it to realize any so called gains, after all you will always need someplace to live.
Paying off your home early is a very personal decision. It’s a decision that’s best evaluated if you can take a step back and look at the big picture. Personally, I don’t like much debt, but debt can be a powerful tool when used correctly or a disastrous enabler.
There are so many sides to this coin, I feel like I could write for days, analyze every scenario and consideration, but then we’d have a book. This is only meant to be a template or guide for things to consider should you find yourself in this scenario.
Consider your circumstances, plan accordingly and make the right decision. Find or use your resources to make decisions you feel confident in and don’t look back. Learn from your mistakes, don’t dwell on them.
There is no one size fits all.
Danny Ratliff, CFP®, ChFC® is the Senior Financial Advisor and Planner for Clarity Financial. He is also a contributing wrtier to the “Real Investment Advice” website. Feel free to EMAIL Danny with any questions or comments.