To Pay Off a Mortgage or Not?

Clients’ ask all the time whether they should pay off their home mortgage. The answer, like most financial and tax questions is “it depends”. As I see it, there is a subjective and an objective answer. Generally, the objective answer makes more rational/numbers sense, but the subjective answer for certain people can create a more peaceful and secure feeling of well-being. My general approach is that if your house represents 10% or less of your net worth when owned free and clear, as their financial planner, I am indifferent about the decision. The client should choose which way feels best for them, keep the mortgage or pay off the mortgage. 

The subjective answer explained. Some people including myself, feel better when they are debt free. These client’s like to pay cash for cars, use no credit card debt and have a general feeling of well being when they are debt free. These people tend to be very financial conservative and have a great sense of freedom from being debt free and having significant investments. Assets only with no debt is for the financially conservative person, the best financial and life situation. If your debt free house is worth 10% or less of your overall asset portfolio and you will get a great sense of well being from being debt free, pay off your house and enjoy the peace and bliss which comes from being debt free.

The objective answer explained. Financial planners are typically numbers and math-oriented individuals. If you have a fixed rate mortgage at a low interest rate like we have in the 2021 environment, the math says that it is inefficient to pay off your mortgage. Let me use an example to illustrate. The 100-year average for large capitalization stocks in the US, such as the S&P 500, is 10%. The blended bond return over 100 years is approximately 5%. A 50% stock and 50% bond portfolio has yielded approximately 7.5% over the last 100 years. Since we are in a low bond rate environment both stock and bonds may yield less than the average. Investing in a 50% stock/50% bond today, tax efficiently, would be expected (not guaranteed) to yield 5.5% after tax over the next 10-20 years. If your fixed rate mortgage is 3.5% before tax, your gain in keeping your money in an investment portfolio instead of paying off your mortgage is at least 2% after the tax effects. 2% of a $500K mortgage is $10,000 a year, 2% of a $5M mortgage is $100,000 a year. In both cases, this is a significant amount of after-tax money annually.

If your house is worth less than 10% of your total net worth and being debt free will give you a great sense of freedom and well-being, then pay the mortgage off. If your home value is more than 10% of your net worth, go with the objective, math and historical proven solution and take the 2 % advantage from keeping the money in a professionally managed investment portfolio. If you have any questions about paying off your mortgage, contact a Certified Financial Planner ™ to get a full evaluation of the options.