Sooner or later, most of us with home mortgages will come to the question, should I pay off my mortgage now, all at once? If I could, why wouldn’t I?
Most of us eventually want to see life without that huge home mortgage payment hanging over our heads every month. And eventually, if we have been able to save some money over the years, and make payments on the interest, there comes a day when it becomes ACTUALLY POSSIBLE to pay the whole thing off in one big chunk.
It is interesting to me how so many people think they understand this question – and that the answer is always YES: “Of course if I had the money, I would absolutely pay off my home mortgage now. Why should I keep paying the bank all of this money in interest every month?” And if we are trying to build our retirement savings, it sure would make the task easier to put some of that money in savings, right?
The trouble is, the answer to this question is not always an easy to determine. Depending on your financial situation, there may be many possible scenarios in which paying off your mortgage is NOT the right move to make, financially (and if not financially, what other reason would there be?).
I’ve spent time considering making this move for myself and want you to have the benefit of what I’ve learned on the topic.
How Will Paying Off My Mortgage Now Affect My Finances?
Like any serious investigation, a hard look at the initial question will produce several others that need to be answered. For most people concerned with building savings for retirement and other purposes, there are two primary considerations that should come into play:
- Can I afford it (i.e., the large one-time payment that will pay the mortgage off all at once), and
- Assuming I can afford it, how will this move help me meet my retirement and life goals sooner or better?
In order to answer these questions successfully you need to have a lot of homework done regarding your own finances.
- To know whether you can afford it, you should have control of your financial picture, meaning you should know how much you are taking in in income vs. how much you are spending, and have a comfortable level of emergency cash available.
- To know how doing this will impact your life goals and retirement goals, you necessarily must have already determined those goals, and have committed yourself to achieving them.
- You must have already put together your retirement plan and be actively working that plan.
- You should know what your current retirement savings and investments are, and what you expect for a return on those investments from now until retirement, and after retirement.
- You should have determined (either with regular help from a financial adviser, or through the thorough implementation of a good retirement calculator, or both) how changes in your retirement inputs impact the successful achievement of your life and retirement goals.
So as you can see, there is a proper order in which you do things before you can make big financial decisions like this one successfully, or with the most chance for success in an uncertain future. The benefits you will gain from getting these tasks accomplished will be HUGE for your financial life (and for your well being and peace of mind), so these are absolutely to be done before you try to answer the question of paying off the mortgage!
I do have guidance on my site for each of the items above that have links – obviously I don’t know your financial situation in detail, I’m just trying to help guide you to organize your thoughts and actions on these important topics so that you have a greater chance for success.
Income Tax Considerations
Once you have determined all of the above, then you can actually start treating this question of paying off the mortgage. The issue of course, at least in the United States, is the income tax deduction that we would lose if we pay off a home mortgage early. To encourage home ownership, in most cases, we are able to deduct 100% of mortgage interest for our primary residence. Several other countries have similar tax laws, or may allow at least a portion of home mortgage interest to be deducted.
So the first investigation to make in answering this question for yourself is to check the tax laws in your particular country. If you are paying interest on your mortgage, and there is no tax benefit for mortgage interest in your country, then the answer may be easier to determine for you. Nevertheless, this post may still provide some insights for you as well – you shouldn’t just assume you know the right answer on this one.
For simplicity, I’m going to discuss this topic as if your mortgage interest is fully tax deductible; if it is only partially deductible, or not deductible at all, then you can simply adjust your consideration of these comments accordingly.
Another critical input is whether or not the money you will use to pay off the mortgage will come from retirement or non-retirement resources. Generally, in the United States, if you take a distribution from a retirement savings account before age 59 1/2, and use it for purposes such as paying off your mortgage, you will be faced with a 10% income tax penalty on that money that you withdraw. Your calculations (and calculator) should be able to account for these penalties in order to get the calculation done properly and so that the results are not overly-optimistic.
You Are Almost Done
I’m going to skip to the punch line. Believe it or not, if you have taken my advice and have completed all of the steps above you are almost done. You can easily determine the current payoff amount for your home mortgage by contacting your bank or other institution holding that loan (it may be available to you through an online banking tool).
Then, assuming you either:
- have a good financial adviser, are keeping that person fully informed of your financial situation regularly, and your adviser is keeping you informed of your position regularly,
- are managing your finances yourself (as I do) using a good retirement calculator, one that takes into account basic tax laws and other considerations associated with home mortgages in your country, and you have implemented it correctly,
you only then need to do the “sensitivity” or “what-if” analysis to answer the question.
Doing The Sensitivity (“What-If”) Analysis
Ask your financial adviser to simply assume you make the home mortgage payoff payment today (or whatever date in the future you want to use as your payoff date). Ask for results assuming several different payoff scenarios (i.e, different time frames, that may take into account changes that you expect to occur during your life and that might impact your life and retirement goals. A good financial adviser should be able to put the results of your what-if cases together in a manner that tells you when the optimal time to pay off your mortgage is.
If you are tracking your financial goals yourself, you have the luxury of being able to do endless “what-if” scenarios, changing the the payoff amount and/or date input into your retirement calculator at will to see how your retirement nest egg is impacted. Your retirement calculator (or the one your financial adviser is using) will be able to keep track of the balance between your mortgage payoff and your retirement savings balance. As it is so easy to do the sensitivities using the calculator (works like a spreadsheet really) you can optimize making this payment using a trial and error method, choosing the date that maximizes your retirement savings at whatever date you choose.
If after doing your sensitivity analysis you find an appropriate payoff date that keeps your retirement and life goals on track, then you can choose to pay off the mortgage on that date. If you cannot find such a payoff date, then you should not plan to pay off your mortgage in an early, lump-sum fashion as this will result in a hit to your retirement savings.
When I did this exercise using my retirement savings calculator I saved quite a few trial scenarios for review, mainly because the calculator was telling me something that wasn’t immediately intuitive to me. it was pretty easy to see that I should not pay off the mortgage early, even though it is well over half-way paid off already, and I could easily withdraw some retirement savings to pay it off, and have more money per month then to invest. In some scenarios I looked at, paying off the mortgage early with a lump sum payment resulted in a mean value for my ending balance at age 95 of more than $100000. Of course, these results depend on many variables and your results will vary – I only mention this to show how significant the decision can be, depending on your individual financial situation.
You now know how to answer the question, “Should I Pay Off My Mortgage?”. Let me know what you think. Post a comment below – I’ll respond! Or, check out my Wealthy Affiliate profile page and leave me a comment there.