How amazing would it feel to live a life free of mortgage debt? Depending on where you are in life, this might be very doable for you. But should you necessarily pay down your mortgage debt?
When you pay off your mortgage debt early, it will likely be at the expense of other financial goals and investment options, while impacting your tax situation. On the other hand, you’ll save money on the additional interest that would have come along with your regular payments. This savings can be significant and will grow with the prepayment amount.
Another reality, however, is that when you pay off your mortgage debt, those funds are no longer yours to invest. And if your interest rate is already low, you’ll benefit less from paying off your mortgage debt.
Let’s Consider An Example
Say the interest rate on your mortgage is 4% and you’re in the 28% federal income tax bracket. Your after-tax mortgage rate is around 2.9% – maybe even lower if you can also deduct the mortgage interest on your state income tax return.
For those who invest, their portfolios are built around a risk tolerance that carries a much-higher annualized expected investment return than 2.9%. For some people, a guaranteed 2.9% savings is more appealing than a higher expected market return, since it’s subject to greater volatility and risk. But for those with a much higher after-tax mortgage rate, paying off mortgage debt early will likely be a more enticing option.
So, how do you decide which path to take? Today we’re sharing 5 questions to help get you started.
1. What Is Your Tax Strategy?
Your ability to deduct mortgage interest might turn out to be very important. Think about whether you’ll still be able to itemize deductions without mortgage interest.
2. Will You Really Invest The Extra Cash?
It might sound like a great plan to invest the cash that used to go towards paying down your mortgage – but do you have the discipline to do that? If you suspect you’ll struggle with this, you’re not alone! There are great options to keep your plan on track, including direct deposits into your brokerage account or increasing your monthly 401(k) contribution.
3. Do You Have More Urgent Financial Goals?
It’s important to take a look at your entire financial story. If you’ve got student loans, credit card debt or still need to add money to your emergency savings, these things might take priority.
4. What Life Stage Are You In?
Whether it’s a solid decision to pay down your mortgage debt will hinge on your life stage and risk tolerance. If you’re nearing retirement you likely have an asset allocation that’s more conservative. In that case, investing the excess cash in the market might spell unnecessary risk for you. At the same time, being debt-free also becomes more important later in life.
5. How Long Do You Plan To Stay In Your Home?
If you plan to remain in your current home for the long run, it makes more sense to pay down your mortgage debt than if you never anticipate paying it off.
Mortgage Debt Looks A Little Different For Everyone
Still on the fence about which decision is best for you when you’re considering paying down your mortgage debt? For now, a healthy middle ground might be opening a dedicated savings account for any extra cash and reconsidering the decision six months’ time. When you separate these funds, you’ll be less likely to spend it on daily expenses in the meantime.
As you think through your options, remember to stick to realistic expectations. Choose a plan that keeps your original plans at the forefront. And always consider discussing this decision with your financial advisor or tax professional before you settle on a strategy.
*Disclaimer: Citywide Home Loans does not provide financial planning services or any other service apart from lending. You should always consult with your legal, tax and financial advisors to determine which strategy is the most suitable for your specific circumstances.