by
Badgley Phelps
| Sep 21, 2021
Many homeowners have debated whether to pay off their mortgages early or continue to service the loans. A recent survey by Bankrate of 1,007 American adults about their top financial priorities showed that Americans’ top priority is paying the bills. As a mortgage is a hefty bill to contend with, there are benefits to early mortgage payoff—and drawbacks as well. The following are several things to consider.
Reduce monthly spending by paying off a mortgage
When weighing the decision to pay off a mortgage, the tipping point for making a payoff might be the reduction of monthly cash spending needs and the resulting increase of financial flexibility. Such considerations may have more importance after a difficult economic or emotional experience, which many people have felt during the COVID-19 pandemic.
In terms of taxes, while you may lose a mortgage interest rate tax deduction, savings from eliminating the remaining interest expense can still be significant.
Without needing to make a monthly mortgage payment, that money can be allocated to other uses, including investments to help you better pursue long-term goals.
Gain peace of mind by eliminating a lien on your home
Another positive result of an early mortgage payoff is the elimination of a lien on your house. Once the mortgage is paid off, many people feel they’ve gained peace of mind which can be an important benefit, especially during a time of personal financial uncertainty.
Owning one’s home free and clear can provide a sense of contentment that might outweigh the potential to leverage investment returns by continuing to carry mortgage payments.
In addition, a mortgage payoff can create an opportunity to open a home equity line-of-credit (HELOC) to provide access to another source of emergency money, if needed. Having multiple sources for emergency money can provide financial comfort and flexibility for many people.
Should I pay off my mortgage or invest?
One drawback to paying off a mortgage early is losing the ability to use the payoff funds to invest. Interest rates are at historically low levels. All things equal, the lower the interest rate on your mortgage, the less compelling it is to pay off the mortgage early. This is related to opportunity cost. By paying off the debt, those funds are no longer available for other investments. If you can find an investment with a higher expected return than the interest rate on the mortgage, you could end up better off financially in the long run than if you had paid off your loan early.
Should I pay off my mortgage or keep cash on hand?
Another drawback in paying off a mortgage early is the loss of liquidity. It’s important to have cash on hand for emergencies and opportunities. Once a mortgage has been paid off, getting access to those funds would require selling the home or taking out another loan against the property.
From a financial planning perspective, it is advisable to pay off the highest interest debt before lower cost debt for a larger return when paying off any loans, including your mortgage.
Tax benefits to holding a mortgage
There are potential tax benefits to holding a mortgage as the interest in the loan may be deductible on your federal income tax return. Mortgage interest is one of the few itemized deductions that are available for many taxpayers. The mortgage interest deduction allows you to reduce your taxable income by the amount of interest paid on the loan during the year. Taxpayers can deduct mortgage interest on up to $750,000 for loans taken out since December 16, 2017, and on up to $1 million for homes purchased before then. Investment property mortgages aren’t eligible for deduction unless you live in the home more than 10 percent of the year.
We suggest consulting an income tax accountant when considering transactions that could have a material impact on your income tax calculations.
Deciding whether to pay off your mortgage early is a personal decision that should be made with the help of your financial planner. To have a discussion with one of our advisers about the pros and cons of paying off a mortgage customized to your unique financial situation and long-term goals, contact us today.
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This blog was originally posted on September 21, 2021.