Debt, Investments, Retirement, Strategies & Tips

Should you pay-off your mortgage early?

If you are like most Americans, one of your largest monthly expenses is your mortgage payment. For individuals, particularly those near or entering retirement, consideration must be given as to whether to maintain your mortgage or pay it off. This decision is guided by both psychological and financial factors, and for many is not an easy choice. The recent introduction of tax law changes has added another factor to consider when deciding whether to pay off your mortgage early.

Psychological vs. Financial Factors

Sound financial planning generally includes the tenant of eliminating debt. Not having a mortgage payment significantly lowers monthly expenses, leaving a homeowner with only the yearly responsibility of property tax and insurance. It is a good feeling to know you own your home outright.

While the “feel good” factor leads many to pay off their mortgage early, there are also financial considerations to be made. Given the recent period of all-time low interest rates, most homeowners have a very low mortgage rate. Financially, if you can earn more after-tax than paying off your mortgage, you are better off financially not paying off the mortgage.

A few things to consider:

  1. You must actually save the funds not used to pay off (or pay down) your mortgage in savings vehicle (brokerage or savings account). You can’t spend the money set aside to pay off or pay down the mortgage.

 

  1. You must earn an after-tax return that justifies keeping the mortgage. In the current environment, this will likely involve some stock market risk which you must be comfortable taking.

 

  1. Your after-tax return must exceed the mortgage interest rate less deductions. Historically, most homeowners have itemized their taxes. As we’ll discuss in the following section, this will not necessarily be true going forward. As such, the after-tax return may now need to exceed a higher rate of return than in the past which may impact your decision.

 

Tax Law Changes

For 2018, the standard deduction has increased from $12,700 to $24,000 for married couples ($26,600 if over 65) and from $6,350 to $12,000 for individuals.

The other two largest itemized deductions are for charitable gifts and state and local taxes. Under the new Tax Act, $10,000 is now the maximum deduction for state and local property tax.

With these changes in effect tax strategies may be shifting as projections show as many as 90 percent may now opt for the standard deduction, avoiding itemizing their deductions. Many families who choose to go this route will no longer be getting the “homeowner’s subsidy,” as a result.

So, should you pay off your mortgage?

For conservative investors and those nearing retirement, the increase in the standard deduction and mortgage interest limitations may now provide a greater benefit to paying off a mortgage. Many also have a financial goal to be debt-free in retirement, therefore paying off their mortgage may create peace of mind.

For more aggressive investors or younger couples willing to invest over a longer period, keeping the mortgage may make the most sense. For example, those with a 30-year time horizon estimating an average yearly return of 8% investing in the market may choose to avoid paying off their mortgage as their investments may generate better after-tax gains. Individuals with a low interest rate on their mortgage may also elect to save their money elsewhere such as savings or an emergency fund.

Let’s look at an example. Instead of paying off your mortgage, you invest these funds in an investment earning a hypothetical 6%. Your current mortgage rate is 3.5%. If you are in the24% tax bracket, the after-tax financial benefit of not paying off your mortgage is 1.90% if you itemize but only 1.06% if you do not. Higher rates of return may financially justify not paying off the mortgage, while an approximately 1% benefit may lead to paying off the mortgage.

 

Itemized Deduction Standard Deduction
Hypothetical Rate of Return 6.00% 6.00%
Tax Bracket 24% 24%
After-Tax Return (ST Gain) 4.56% 4.56%
Mortgage Rate 3.50% 3.50%
Mortgage Rate after Tax Benefit 2.66% N/A
After Tax Benefit 1.90% 1.06%

 

Conclusion

Every situation is unique and recommendations will drastically differ depending on various factors, including time horizon, risk tolerance and personal preference. We strongly suggest consulting with your team at Republic, or your own financial advisor, in coordination with your CPA to better understand the potential implications of paying off your mortgage early.

 

 

IMPORTANT DISCLOSURE INFORMATION: Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Republic Wealth Advisors), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Republic Wealth Advisors.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Republic Wealth Advisors is neither a law firm nor a certified public accounting firm and no portion of this blog content should be construed as legal or accounting advice.  If you are a Republic Wealth Advisors client, please remember to contact Republic Wealth Advisors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Republic Wealth Advisors’s current written disclosure statement discussing our advisory services and fees is available upon request.

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