Financial Planning Blog

Where should paying off your mortgage fit in your financial priorities? This is a question that should be on any mortgage holder's mind as they sort through the myriad of competing financial objectives. Like a number of personal financial topics, this is one where reasonable people may come to different conclusions. And this should be no surprise, after all this is personal finance--where math and economic theory often take a backseat to emotions, behavior, and relationships.

For starters, let me state my general opinion on the topic. Yes, you want to get your mortgage paid off--certainly by retirement, hopefully sooner. Paying off your mortgage has significant advantages in lowering the overall financial risk in your life and managing your post-retirement cash flow. For most people, but maybe not everyone, there are also exceptional emotional benefits to being totally out of debt. However, before you rush to make that extra payment, realize that a number of other financial priorities should take precedence over paying off or down the mortgage on your home. Don't let a good thing become a bad thing by doing it at the wrong time.

Things to do before paying off your mortgage

You've established a foundation of spending less than you earn, and now it is time to start putting those "excess" funds toward your top objectives. Some of the objectives that should clearly come before accelerating the payoff of your mortgage are:

• Pay off other debt first: Credit cards, auto loans, and other consumer debt are usually at higher interest rates and not tax deductible. It makes absolutely no sense to pay any extra on your mortgage when you should be aggressively eliminating these higher cost loans. Although eliminating student loan debt may be lower on the priority list than consumer and auto loans, you should generally still place it at a higher priority than attacking the mortgage.*
• Establish an adequate emergency fund: Things happen, and someday you will undoubtedly need quick cash for something unplanned or unexpected. Financial advisors almost universally suggest maintaining a savings or "emergency" fund of somewhere between 3 and 12 months expenses in a safe, accessible interest bearing account. The right amount varies from family to family, depending on numerous factors--job security, health, other funds to access, and risk aversion to name a few. The key here is to be able to handle the financial crisis without accessing credit--credit which may not be available to you when you really need it.**
• Regular savings earmarked for planned major purchases or other requirements: With a minimum of forethought and planning most of us can anticipate approximately when we will need to purchase replacement vehicles, and estimate how much this will cost. By saving for this major purchase up front, we avoid the need to take out a car loan. It makes absolutely no sense to accelerate paying off your house if it means you will not have adequate funds left to purchase your next vehicle. The same is true for vacations, weddings, furniture, appliances, and other major purchases. You should be at a point in your life where all major purchases are made from savings before you consider paying off your mortgage.
• Investing for retirement at an adequate rate: The concept here is that you should be investing sufficient funds in tax-advantaged accounts (traditional or Roth IRAs, 401Ks, etc.) to put you on-track to accumulating sufficient assets to fund a reasonable retirement. Of course, what is sufficient, on-track, and reasonable differs from family to family. If you are fortunate enough to have a generous defined benefit pension plan, you likely don't need to be as aggressive in your personal retirement savings. If you are like the majority of Americans in private sector employment without pensions, you need to fund this objective at a high rate for a long time. If this is your situation, figure you (and potentially your employer) should be putting at least 15% of your income into tax-favored retirement accounts before accelerating the mortgage payoff. It's not that putting your resources toward the mortgage isn't a good thing--it is. However, you will likely have a better long term outcome if you can multi-task--investing enough for retirement, even though it means taking a few years longer to pay off the mortgage.
• Adequate insurance to protect your family: The key motivation to paying off your house is to lower your overall risk profile. Don't make the mistake of under-insuring your family against key financial risks in order to accelerate the elimination of your mortgage. Certainly, you want to be a smart consumer of insurance, and avoid over-insuring for risks you can assume. However, make sure your have adequate term life insurance and disability insurance to protect your family from the loss of a key breadwinner's income. Also, maintain sufficient medical, automobile, homeowners insurance to protect yourself from devastating losses and liability claims.

Don't take this somewhat long list of priorities as a reason to give up on paying off your mortgage. At Table Rock Financial Planning we believe having an objective to pay off the mortgage, sooner-than-later, should be part of most everyone's retirement plan. In Parts 2 and 3 other thoughts and issues regarding the decision to pay off your mortgage will be considered. In the meantime, here are two other takes on the subject from Ron Lieber (New York Times) and Liz Pulliam Weston (MSN).

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*There are situations where it would make sense to pay off a mortgage before student loans, but these are certainly not the norm. It depends on your loan (student and home) balances and terms (interest rates, payments, length of term, etc), your tax situation, and your potential fit for a federal student loan forgiveness program.

**Paying down (or off) your mortgage does increase your home equity which is theoretically available in a financial pinch. However, it is usually somewhat time consuming and expensive to access this home equity in an emergency. Some financial advisors suggest establishing a home equity line of credit (HELOC) up front, before you need it in an emergency. Personally, I prefer having a sizeable emergency fund that I control, as opposed to counting on the access to credit via a HELOC.