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The Pros and Cons of Paying Off a Home Mortgage

July 25th, 2009 at 12:34 pm



I'm roughly halfway through a 30-year fixed rate mortgage.

My balance is low enough that I don't think it would make sense to refinance from my current 6% rate, given the closing costs.

I would love to be completely debt-free.

Yesterday, I came upon an article written by some researchers at Boston College Center for Retirement Studies.

They went into great detail and explanation, but the bottom line of their paper was that, given today's current low interest rates, it makes sense for most people to pay off their mortgage if their mortgage is more than 2%.

Tax deductions on the interest paid really don't make up for spending thousands extra on interest payments, they concluded.

For example, I'm looking at my current amortization table right now. I just sent in my August payment, and $316 of my total payment was purely interest.

So this loan is costing me (right now) an extra $300 and more in purely interest each month, month after month. In my mind, it's like throwing money away. I get nothing extra for that money. Yes, it slowly decreases, but still, why not pay it off when I have the money sitting in various mutual funds that are performing pretty horribly?

If I continue throwing extra money at it in the form of monthly prepayments, I will still pay it off in six more years.

However, if I chose to pay off the entire loan now, or perhaps a big chunk of it now, I could save up to $12K in interest.

The money I would use to pay off all or a portion of the mortgage would come from one of my taxable mutual fund accounts.

So, looked at this way, it seems clear that I'd be better to pay off a 6% loan than let the money I'd use for that sit in a fund that's earned me about 4%. I also pay an annual expense charge of 0.83% on that fund.

However, I'd probably take a loss on the withdrawal from that fund. I guess a pretty big loss since as I said, I've had that fund a while and I know most of the contributions I made to it were made during the bull market.

But I'd been wanting to move that money to another account anyway in my gradual moves toward having only low-cost index funds for investments and simplifying my investments overall.

I think that was the important distinction in the Boston College analysis. They were only considering whether it was worthwhile to pay off a mortgage using money from a money market account, which as you know, won't earn more than 2% these days. In that context, they said, it would make sense to use money market money earning 2% to pay off a mortgage.

Using stock or bond mutual funds is a whole other beast because you'd have to factor in the loss you'd lock in if you withdrew that money from investments you made near stock market peak, paying higher prices per share than now. So maybe it doesn't make sense.

Another valid concern in paying off the mortgage is the loss of a great deal of liquidity, particularly in these uncertain economic times.

Yet another risk is that while I say now that after paying off the mortgage I would throw all savings into retirement, I may not be so diligent in reality.

One alternative would be to pay off only a portion of the outstanding mortgage and so preserve a greater portion of my liquidity while still reducing total interest paid on the life of the loan.

What do you think? Your feedback is welcome!