Financial Planning Blog

In Part 1 we looked at several financial objectives that should clearly be addressed prior to accelerating the payoff of your home mortgage. Once you have a handle on these priorities, should paying off the mortgage come next? Not so fast! Some legitimate reasons for not aggressively tackling the mortgage are outlined in Part 2. Although a persuasive argument for overall wealth creation can be made for maintaining a mortgage and investing that equity elsewhere, not everyone is convinced.

At Table Rock Financial Planning we understand that your personal finances are not just about math, nor is maximizing your portfolio by age 60 your sole objective. You are managing your finances not only for wealth creation, but also to minimize your family's risks. You undoubtedly place a significant value on financial security and your family's peace-of-mind.

Advantages to paying off your mortgage

• Your highest risk-free rate of return: Except for paying off other, higher cost debt, paying off your mortgage almost always provides you with the highest available risk-free rate of return.* When you pay off your fixed-rate mortgage, you know exactly what your rate of return will be. It is more than likely going to be higher than FDIC insured savings accounts and CDs, money market funds, or Treasury bills and notes. Yes, you can possibly make a higher return elsewhere (see Part 2), but you will need to take some additional risk to do so.
• Lower overall portfolio risk: When you consider the risk of your family's complete portfolio of assets, paying off your mortgage will almost always lower your overall financial risk. If the alternative to paying off your home is to invest in even a conservative, diversified portfolio of stocks and bonds, you will still be exposed to a higher level of financial volatility. And, if the alternatives are to keep holding that concentrated position in your employer's stock, trying your hand at trading options, investing in your brother-in-law's start-up company, or maybe buying some rental property, you have will have vastly increased the risk you are taking with your family finances. And, please don't assume that holding gold or other precious metals will be a "safer" place for money earmarked to pay off your mortgage. It may work out well for you, but so can a trip to Jackpot or Vegas. (Thank you Carl Richards for another helpful illustration.)
• More spending discipline: When you have the assets to pay off your house (or the cash flow to accelerate your payments), but instead choose not to do so, you may feel a bit richer. Will those funds sitting in your brokerage or checking account tempt you to spend more on going out to dinner, a new boat, or possibly an expensive vacation? This isn't to say that spending on some of these luxuries is wrong, but will the available cash tempt you to spend more than you really want, or should? Will paying off the house help you to act smarter and make better decisions?
• More investing discipline: Helping you to control expenses may not be the only way that paying off your mortgage enables you to act smarter and make better decisions. Will a paid off mortgage give you the peace-of-mind and confidence to stay invested during down markets? Not panicking and bailing out of the market at bad times, and then missing the eventual rebound, is critical to capturing favorable long term returns.
• Reducing your cash flow needs in retirement: Having your house paid off will reduce your cash flow needs in retirement. This will enable you to have a lower, safer withdrawal rate from your portfolio, and result in a higher likelihood of not outliving your retirement assets. (Granted, your portfolio will assumedly be smaller, since you will have used funds to pay off your mortgage.)
• Reducing your cash flow needs prior to retirement: With no monthly mortgage payment, your lower monthly cash flow requirement will put you in a better position to weather a financial hardship, such as a job loss or short term disability. Yes, having the money you used to pay off the house sitting in investments would also be helpful. But, consider the possibility that in hard times these funds may be invested in assets that have lost considerable value, or be tied up in tax-deferred accounts. (Also, the assumption is you have established an adequate emergency fund prior to eliminating the mortgage.)
• Funding college expenses: If you can pull it off, eliminating the mortgage before your children hit college can be an effective strategy. First, and most obvious, you free up considerable monthly cash flow to put toward tuition and other expenses. Of course, you could have been investing the money you used to pay off the mortgage in accounts earmarked for college. Saving for college, especially in 529 plans or other tax advantaged accounts, is certainly to be encouraged. However, when it comes to qualifying for financial aid, you may be better off with a paid off house (and higher available monthly cash flow), than with a big 529 plan or non-retirement brokerage account. This is because federal financial aid formulas and the FAFSA form ignore your home equity, but do consider the investment assets in the 529 plan or brokerage account. Be aware, though, private colleges that use the institutional methodology and CSS profile may consider your home equity to some degree.
• Because it feels so good: As Dave Ramsey is fond of saying, "After you pay off the mortgage, take off your shoes, walk through the backyard--the grass feels different under your feet". And, that's different in a good way, let me tell you!

Maybe these reasons don't motivate you to pay off the mortgage earlier-than-later. Maybe you aren't one of us who gets a big emotional boost from completing such a huge objective. Ask your spouse, however. Usually, at least one of you would sleep much better at night knowing that the house was paid for. Have some serious discussions on how paying off the mortgage fits into your overall financial plan. And then, if it is right for you, get after it with a passion. Check it off the list and be done--it will feel great!

--------------------------------------------------------------------------------------------------------------

*The only time this is not going to be the case is if you have an extremely low interest fixed-rate mortgage, and current interest rates have spiked up considerably higher. I'm not sure when the last time the stars were aligned like this, but I assume it was over 25 years ago.