Home > The Pros and Cons of Paying Off a Home Mortgage

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

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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!

9 Responses to “The Pros and Cons of Paying Off a Home Mortgage”

  1. frugaltexan75 Says:

    Maybe instead of paying off a huge chunk at once, or the whole thing, just increase your extra payments to maybe $1,000/month. That way you'd still have the vast majority of the money sitting available, but you'd also be paying the mortgage off faster. (And you wouldn't have extra money sitting around tempting you to spend.)

  2. Ima saver Says:

    Having been mortgage free for over 30 years, I'd say, go for it! Pay it off and keep saving your usual payment and extra principal payment! You will soon build your mutual funds back up.

  3. creditcardfree Says:

    frugal texan, makes a good point about increasing the extra payments. These could come from regular income, or your investments. If you pull them from investments, you take advantage of the fact, that the price may increase, giving you more money to work with.

    Overall, I say start making a plan, but give yourself a couple of months to make sure this is right for you. Worse case, you have to borrow on your house again...but there are closing costs with that scenario, too. And who knows where interest rates might be.

  4. thriftorama Says:

    When hubby and I bought this house We paid for about half of it with proceeds from the sale of our house in New Orleans. Because we d gone through hell with our mortgage bank after H. Katrina, we decided that it was worth it to cash out some stocks to pay off the other half. Having a paid off mortgage is liberating, and I believe it does make financial sense. The money we would have spent on a mortgage, goes to savings, college funds, investments, etc. It's like getting a guaranteed 6 percent return on your money.

    And, given that the stocks we sold to pay off our house have since tanked in value, we feel even better about the deal. And frankly, we don't miss the tax deduction. It's a false economy.

    The fact is, if you have the money in addition to an emergency fund, pay off your debt. with banks paying 1 percent on savings and the market in shambles, it's the best return on your money.

    Also, if you have lost money on the stocks you'd be selling to pay it off, you'd be getting a tax deduction for capital loss.

  5. debtfreeme Says:

    I would pay it off. If something happens with work, you have a place to live free and clear. The investments will take care of them selves.

    And if you are worried about easing up on the savings and putting more money toward living life, allow your self a set amount that now you can save for "fun life things". Put away 250 (or some figure) into a saving account at your local bank. Allow yourself to use that money for the living life itmes you want to do. Some months you may use it, other you might not. At the end of the year, put the majority of the money left into investments and start again. You should be able to have a little more fun and still save for retirement.

    If I had the money to pay off a house i would do it!

    Also, ask your tax advisor the consequences and get their opinion. but if you have it, do it!

    although as i type this i remember you talked about oving to condo living at some point in your future? hm....i think i'd still pay it off.

  6. gamecock43 Says:

    I see nothing wrong with paying it off. You make a compelling argument and have put a lot of thought into it.

  7. baselle Says:

    The interest argument (pay off a high interest loan/mortgage w/low or no interest savings) is compelling - I'd give it serious consideration. Not only would it give you peace of mind, it means that you will never be forced into a short sale should you want to sell it. Also want to consider what accounts you are going to liquidate to pay off the mortgage in terms of the taxes you save. If you pay with individual stock that you bought at a high price (not sure about mutual funds), you could liquidate and write off the capital loss (help with taxes), use the proceeds to pay off your house.

  8. swanson719 Says:

    I would pay off as much as you can without incurring great penalty for withdrawing from retirement accounts. If that's $25K or the whole amount, the more the better, so long as you still have an EF handy. The risk you run is the market coming back while the money is out and you losing out on the theoretical returns of having the money you do in the market. Unless you plan on making more than 6% in the next 5 years, this is still the best idea. But you might be kicking yourself 5 years from now if the market is at 15,000. That's the only big downside.

  9. scfr Says:

    Do you have a tax advisor? If so, you might want to ask them to run the numbers and let you know the tax consequences of selling off shares in your non-retirement mutual fund(s). Assuming no negative tax consequences, if I were in your shoes I'd probably pay down 1/4 - 1/3 of the mortgage, then wait about 6 months and reassess your entire financial situation (job status, etc), and consider paying down another 1/4 - 1/3, and continue that process until it was paid off. Assuming no setbacks like a layoff, you could then have the entire mortgage paid off in a couple years. But if you suffer any sort of setback, you won't be squeezed for cash.

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