By: Ilyce Glink and Samuel Tamkin
Q: My husband and I bought a new house a few years ago and are getting ready to sell our old house. With the sale of the old house, we should be just about able to pay off our current house that is about 3 years into a 30-year mortgage. My husband thinks that we should not pay off our current house since there are tax deductions available on the interest that we pay. We are currently 51 and 48 years old and our retirement funds are not adequately funded. Is there any simple advice you could give for our situation?
A: In general, we don’t believe that tax deductions alone make it worthwhile to carry mortgage debt. However, if you have an extraordinarily low interest rate, there’s a case to be made for keeping it. After all, once the economy recovers, it may be impossible to get a 30-year fixed-rate mortgage for 4.5 percent or less. And, there will be plenty of places to invest at higher interest rates.
But let’s start at the top. The first question is whether at 51 and 48, with presumably 15 to 20 years to go until retirement, you want to use your free cash to top off your retirement savings all at once, or if you’d rather pay off your mortgage and then use your monthly mortgage “savings” to plow extra into your retirement account.
Let’s see how this plays out in real time. We assumed you’d net $200,000 on your sale. If you keep paying your monthly mortgage and instead put that $200,000 into an investment that earns 5 percent per year, you’d have $542,528 at the end of 20 years. That’s pretty darned good. (It’ll be even better if you can put some of this investment into a Roth IRA as the years go on, so that it grows tax-free.)
While that sounds like a clear proclamation for investing the $200,000, you’d still have your monthly mortgage to pay. Let’s assume your new mortgage is for $200,000 at 3.5 percent. Your monthly payments (not including real estate taxes or insurance premiums, which you’d continue to pay regardless of when you pay off your mortgage) would be $898. Over the life of the loan, you’ll pay $123,312 in interest on this loan.
To make the comparison fairer, you’d pay off the mortgage and free up $898 per month. If you invest this over the next 20 years, you’d wind up with $369,110. Or, about $180,000 less than if you had invested the $200,000 outright.
It’s clear from your email that you’re more worried about funding your eventual retirement rather than paying your mortgage. The best thing you can do is to invest your $200,000 windfall and then, out of your existing funds, work on paying down your mortgage as quickly as possible. Making two extra payments per year will shave about 7 years off the remaining loan term. That would help you pay off the loan in about 20 years, which is about when you and your husband will be ready for retirement.
The goal should be to eliminate a mortgage payment once you’re in retirement, when cash flow tends to be a little tighter and most Americans are living on a fixed income. We actually wish more baby boomers would keep this in mind.
Recently, we’ve seen other financial experts recommending people like you to keep your mortgage for as long as possible. While you can keep your mortgage longer, the issue is where you will invest your money, how well your investments will do and what will you do with other cash you have in hand.
If you can invest prodigiously and carefully, keep the money invested (as opposed to trying to time the stock market), and spend carefully, they are probably right; you might do much better investing in stocks and other investments over the long run. But for many Americans, being diligent about their finances and investments is given less time and thought and is frankly a lower priority that picking the right cable TV package.
If we’ve just described your approach to your personal finances, the savings you will reap from not having a mortgage will be greater than if you end up investing poorly or spend on items that you wouldn’t otherwise buy if you didn’t have the money.