Why not pay off the mortgage early if you have the chance? After all, do you like debt hanging over your head?

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But paying off the mortgage early — and being free and clear of your largest debt — might not give you the peace of mind you would expect. Indeed, your rush to payment could be a gross misuse of your money, leaving you with a false sense of financial security.

Here’s why it’s not smart to pay off the mortgage early:

1. Mortgages are a truly cheap source of funds.

Unlike the early 1980s when mortgage rates topped 18 percent, mortgage rates today are four, five or six percent, depending on your credit history. Compare that low percentage to Thursday’s (Sept. 4, 2014) fixed and variable credit card rates of 13.02 percent and 15.66 percent.

So, if you decided instead to pay off all your credit card debt, you would receive a far more sizable return on your investment. Pay off credit card debt at 15 percent, your return is 15 percent. Pay off credit card debt at 18 percent, your return is 18 percent. These are far smarter moves than paying off your relatively low-rate mortgage.

2. Throwing a lifeline to an underwater mortgage is dumb.

You know the old saying, “Don’t throw good money after bad.” After the past recession, millions of Americans found they owed more on their mortgages than their houses were worth. To try to emerge from that situation by pouring more money into the house to increase your equity just isn’t smart. Rather, let a rebounding market make your house whole again, without the use or help of your money.

And were you to short-sale your house, with the bank’s permission, in many “non-recourse” states you’re not obligated to repay the lender, regardless of how much you left the bank short.

3. Mortgages give you tax advantages.

Every year, Americans recover about $100 million from the IRS in the mortgage interest deductions filed on their tax returns. In other words, the government has been subsidizing your homey lifestyle. Why end that cozy relationship?

Every time there’s talk of a limiting or erasing the real estate tax deduction, there’s a popular uproar to preserve it. Those in the highest tax brackets, as well as those who have bought a home more recently (when the bulk of your mortgage payment goes toward paying off interest, not principal) realize the greatest tax advantages.

But even if you’re in the 25 percent tax bracket, your 6 percent mortgage could be as little as 4.5 percent if you itemize, and even less when you factor in state income taxes (your tax rate depends on the amount of interest you pay and the total of your other itemized deductions.)

4. Mortgages let you pay back with inflated dollars.

This is Econ 101. Whatever you borrow and have to pay back later is a good deal in the sense you’re paying back the money with a devalued currency. The $1, $100, or $100,000 that you agree to pay back in the future will not be worth as much as it is today. The money you’re agreeing to repay will be an inferior product. It’s like paying back in gold or silver plate instead of the real thing. The metals’ value has been eroded by inflation. Similarly, a dollar 25 years from now probably will be worth less than 50 cents in today’s money, given a 3.1 percent inflation rate.

So, if someone told you that you had to pay her back, but said you could make repayments with cheaper money, wouldn’t you take her up on it?

5. By not paying off the mortgage early, you stand to gain more financially.

First off, you would never decide to pay off the mortgage at the expense of a better investment proposition. And there are few better than your employer’s workplace matching program, or 401(k), which typically matches 50 percent of your contribution up to 6 percent of your pay. If you’re not contributing enough to at least get the full company match, you’re missing out on a 50 percent return on your money.

At the same time, those dollars you’re dropping into your 401(k) plan reduce your tax liability. Were you to pay off your mortgage instead, you would not only lose your mortgage interest tax deduction, but you would be paying more in taxes because you would not be sheltering any contributions in a retirement account. You’re losing two different ways!

As for how much your investments will return in a retirement investment account are anybody’s guess, but historical data over 20- to 30-year periods shows that an asset allocation mix of 60 percent stocks, 30 percent bonds and 10 percent cash would yield an average of more than 8 percent, about double the rate of what mortgages are priced at today

The Federal Reserve is also in your corner when it comes to finding better investment vehicles for your money rather than seeing you choose to pay off your mortgage early. The Fed found that homeowners who pay off their mortgages early, rather than contribute more to their retirement accounts, blow more than $1.5 billion a year, or about $400 per household.

The same research revealed that at least 38 percent of those prepayers were “making the wrong choice.” Had they invested more in their retirement accounts instead of paying off their mortgages, they would have gotten back 11 to 17 cents more on the dollar.

Money not used to pay off the mortgage can also be targeted toward more immediate needs, such as building up an emergency fund equal to a minimum of three months’ expenses. If other people depend on you financially, you might also consider taking out life insurance or increasing the size of an existing policy.

Another use for that mortgage payoff money could be taking out long-term disability insurance, which fewer than 30 percent of all workers have, despite the fact that one in seven U.S. workers is disabled for five years or more before age 65.

6. If you’re already collecting Social Security, a mortgage payoff could send your income tax rate soaring.

If you were to pull money out of a retirement account to pay off your mortgage early, that money you withdraw and apply to your mortgage would count as yearly income. But Social Security benefits are only tax free up to certain income limits.

You have to pay tax on part of your benefits if you’re combined income (from wages, investments, tax-exempt interest and half of your Social Security benefits) exceeds these thresholds:

— $32,000 if you’re married and file a joint tax return (as most couples do)

— $25,000 if you’re single

Here’s the shocker: If your income is more than $44,000, up to 85 percent of your Social Security benefits is subject to income tax, putting you in the highest tax bracket in the country.

So, the last thing you would want to do is trigger a taxable event like that just because you want to pay off your mortgage early.

Free and clear versus smart and sensible

If the thought of being saddled with a large debt raises your blood pressure and gives you insomnia, paying off your mortgage early should bring you great comfort.

Just keep in mind that it won’t, however, bring you the same kind of comforting financial return.

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  • Angelo_Frank

    Fewer seniors are heading into their golden years mortgage free. That’s bad news for this burgeoning American demographic, which is expected to grow to 132 million by 2030. Also scary: A third of adults aged 50 and over — and 37% of those 80
    and over — dedicated 30% of their income to housing. Nearly half of those nearly 20 million households had severe housing cost burdens, meaning more than half of their income went toward housing. To accommodate high housing costs, these seniors have cut back on food and health care expenses.

  • Peter Bennett

    It’s truly a mess. Honestly, I don’t know how people are going to make it. With medical and long-term care costs also spiraling out of control, I’m finding it hard to be optimistic about the future. That’s why if you have a little nugget of cash, it’s better to hold onto it. Just so many rainy days out there!

  • highinterest

    I tell my tax clients, “If you’re no longer itemizing, even with the mortgage, consider paying it off. If you’re more comfortable paying it off than having it and investing the extra funds you have at a higher rate, consider paying it off. If you’re making more by investing it, you may wind off behind after taxes, so consider paying it off.”

    As for your list–I have no argument with #2 or #5. #3 depends on whether the person is itemizing. #4 was very much a concern in the 1970s and 80s, even in the 1990s, but hasn’t been nearly the problem this century, as inflation hasn’t been nearly the issue it was when I was young, thank goodness. I’m not sure what #6 is trying to say, since the amount of Social Security that is taxable depends on your other income; IF you’re itemizing, your taxes may go up because your itemized deductions go down or you may not be itemizing after the payoff, but neither effect how much of your SS is taxable.

  • Peter Bennett

    Your points are well taken. I’m going to do a little more research on the Social Security point, but it’s my understanding that were you to pull money from, say, a 401(k) or IRA, that amount would add to your total yearly income, which when added to half of your SS benefit for the year could put you over your yearly SS tax threshold benefit. By exceeding this limit, you would thereby reduce your SS benefits. To keep from triggering this event, I wouldn’t want to withdraw the sum needed to pay down or pay off my mortgage, one more reason not to pay off. The thought of living with a mortgage is dreadful, but sometimes it does make sense.

  • Shane

    you should stop pushing #3. the annual tax savings is much smaller than the amount in interest youre giving the lender.

    #5, are you really advocating to stay in debt at the benefit of investing? you may as well tell your readers to take out a HELOC so they can invest that too. assuming you were debt free and you paid off your home early too, can you imagine the amount of growth youd have putting that house payment into mutual funds? i can tell you ive run the numbers your way and my investments are worth way, way more paying my home off early. you’re also pretending there is no risk, or that youre super comfortable with risk.

    • jonmark28

      good that you are at least somewhat open to hear why paying off a mortgage is not the best option, because you are reading articles like this. If you truly understand the power of compounding interest, you would know that the earlier you invest, the greater impact is had in the last years. When you delay that investment to avoid low interest costs by earning 3-4% rather than 7%, you aren’t better off. I am 45 years old and have almost 1 million in net assets and have never earned 6 figures. I am disciplined and invest the difference in my 30 year mortgage and what a 15 year mortgage would have been. Maybe even a little more. It’s working for me. When I am paying my 2,000 mortgage in 15 years, it will only feel like 1,500 or even less depending upon inflationary devaluation of my money. Why give that money to the bank early. Investigate opportunity costs, what you forgo when you sink your money into your house just to have it paid off. Keep searching and good luck.

      • Shane

        would you borrow $300,000 at 3% interest to invest @ 8%?

        why not pay youre house off super early and then invest what your mortgage payment was?

        what youre telling me is risk doesnt matter or youre comfy with it,