Were you raised to hate owing money to anyone? Maybe you started trying to get your finances under control as an adult and had to cut up a stack of credit cards. Regardless of when you started, you’ve probably gotten the message that debt is bad.
But is debt always bad? Some people might say yes. Others might try to draw the distinction between good and bad debt. A home mortgage is the most commonly cited example of “good debt.” If you’re making good headway on your financial goals, you may want to figure out whether trying to go mortgage free is the right choice for you.
Running the Numbers
Once you’re mortgage free, a big monthly expense will drop out of your budget. What you would do with any extra money you save? It’s human nature to think that our budget would be easy to balance if we just had a little more money, but in practice our lifestyle tends to expand at the same pace as our income.
If you take the money you would have spent on a monthly mortgage payment and invest it aggressively, you’ll probably end up with a higher net worth in the long run. This is especially true if you start early on in your mortgage term—due to compounding interest—or if you have more time before retirement for your investments to pay off.
However, there are a few more factors to consider before you write a giant check to your mortgage holder.
First, do you have a robust emergency fund? A house, especially if it’s your primary residence, is not an asset that’s easy to liquidate. You can use a home equity loan or line of credit to get some cash to spend, but that’s not something you can set up on the spot.
Second, are there prepayment penalties written into your mortgage? FHA and VA loans do not have prepayment penalties, but some private lenders might. The lender is required to disclose these penalties up front, so check your mortgage paperwork to be sure.
On the other end of things, maybe you have an ARM or other unusual loan structure. In that case, paying things off early, before your expenses balloon, can save you even more money over time than if you had a traditional fixed-rate mortgage.
What About Tax Deductions?
You might have heard that getting rid of your mortgage is a bad idea because you will lose out on tax benefits. While it’s true that you can deduct mortgage interest on your taxes, this only applies if you itemize deductions. If you take the standard deduction, this doesn’t matter at all. If you do itemize, you should consult with your tax accountant or financial planner to determine if this deduction is really making a difference for your tax bill.
Planning for retirement
What if you don’t have 30+ years to work with when you’re planning your finances? If you’re approaching retirement, paying down your mortgage might feel necessary in order to guarantee that you have a place to live once you can no longer work. But it might actually cause more problems in the long run.
For one thing, if you’re near the end of your mortgage term anyway, paying it down faster saves you very little in interest. It’s probably better to put that money into your investments, even if you’re being more conservative with those in preparation for retirement.
Meanwhile, if you don’t have a robust emergency fund and plenty of retirement savings, you might find yourself in a situation where you have to use your home equity to stay afloat—taking out a home equity loan, getting a reverse mortgage, or even selling your home in order to pay the bills. In most cases, this will be significantly more expensive than having your original mortgage.
If, however, you’ve managed to squirrel away enough money that you’re not worried about running out during retirement, paying off your mortgage can make estate planning easier.
Next Level Prepayment: Paying All Cash
Proponents of paying off your mortgage early often present being completely mortgage free as the ultimate goal. Just pay cash for any house you buy and skip the mortgage altogether!
However, this is not necessarily as good as it sounds. If you have enough assets to pull this off, where is that money now? Is it sitting in a savings account failing to gain interest? Is it tied up in investments? Be aware that selling many investments at once can lead to a big capital gains tax bill!
In some housing markets, however, the disadvantages of paying cash can be worth it. Many urban areas have a shortage of desirable housing. Sometimes it’s nearly impossible to get your foot in the door if your offer is dependent on securing financing. In that situation, saving up enough to make a cash offer can improve your odds considerably.
If you pay cash, you never have to worry about being upside down on a mortgage if a housing bubble bursts. On the other hand, there’s less opportunity to profit if you buy right before a boom in the housing market. For example, say you pay $300,000 for a house and its value increases to $400,000 a year later. You could sell it and pocket a tidy profit of $100,000, a return of 33% on your investment. On the other hand, if you put $60,000 down, you’d get the same profit of $100,000 (minus some closing fees and other costs) with a much smaller initial investment. Meanwhile, you could have used the rest of the money to invest in other things!
You Don’t Have to Go It Alone
A house is probably the biggest purchase you’ll ever make. A home is one of the most emotionally charged purchases! With so much on the line, you might feel lost, but you don’t have to travel through life without a guide. Contact us today and we’ll connect you with a financial advisor who can create a road map tailored specifically for you.
