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Marc A. Hebert's Money Sense: It doesn't always pay to pay off your mortgage early

November 17. 2017 7:59PM

I have always believed that reducing debt whenever and wherever possible is a good strategy. But paying off your mortgage as you grow older might not always be in your best interest.

The idea of having no monthly mortgage payment and having outright ownership of your home is indeed an appealing prospect, especially if you are depending on a fixed income during retirement. The money used to make your mortgage payment is freed up for other uses. But does doing this make financial sense?

To answer this question, you need to first consider your opportunity cost, which is what else you could be doing with the money that would be used to pay off your mortgage. If, for example, you are looking to pay off a $100,000 mortgage, you should first consider where you could invest that money instead and what rate of return you could earn. In general, if the rate you could earn is higher than your mortgage rate, you might be better off keeping the mortgage. For example, if you have a conventional 30-year fixed-rate mortgage with a 3.5 percent annual percent rate (APR), but you could earn a 5 percent rate of return on your portfolio over time, you might be better off investing the money instead.

This general rule applies even after taxes are factored in. The interest portion of your mortgage payment might be tax deductible, which reduces the effective interest rate of the mortgage and adds incentive to invest your money elsewhere. But income derived from any alternative investment is taxable, reducing its effective yield, so it might be a wash.

Flexibility is an important consideration. Money tied up in real estate is not liquid. If you want to tap into that money, you will either need to take out a mortgage or sell the property. Money held in a traded investment, however, is much more liquid. In the case of stocks or mutual funds, you can convert those assets to cash within days. And, should you need to draw down this money to pay for living expenses, it is fairly easy to do so if it is held in liquid investments.

Consider how much you will actually earn on investing the money instead of paying off the mortgage. Market fluctuations could limit the gains on your investments, and you could lose money. On the other hand, by no longer paying interest on your loan, it can be like earning the equivalent risk-free interest rate. One way to analyze this is to calculate what you could earn on an after-tax return of a low-risk investment.

Depending on the length of your mortgage and the size of the debt, paying off the mortgage might save you considerable amounts of interest.

Reasons you might want to keep your mortgage include the need to devote the extra money to increasing your 401(k) contributions. You might also want to pay off higher rate debt first - especially outstanding debt like credit cards. The money could also be used as an emergency reserve to cover an unexpected expense.

If you are moving in a few years, it might make sense just to maintain the mortgage and save the amounts you would have used for other expenses.

So, if you are thinking of paying off that mortgage, make sure you first check out the alternatives and consider what kind of cash cushion you might need in the years ahead. It is important to crunch some numbers and do some long-term planning. This is a big decision, and as you can see there are many points to consider.

Marc A. Hebert, M.S., CFP, is a senior member and president of the wealth management and financial planning firm The Harbor Group of Bedford. Email questions to Marc at Your question and his response might appear in a future column.

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