Does It Make Sense to Pay Off Your Mortgage?by , CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
July 15, 2009
I have over $600,000 in CDs at 3% interest. I have a mortgage balance of $100,000 at 5.125%. Would you advise that I go ahead and pay off my mortgage or leave the money in CDs?
On the surface, the answer to your question might appear to be a simple calculation. But in reality, the decision to pay off a mortgage can be more complex. So I’m going to start by posing a few more questions that you may want to factor into your decision.
For instance, how many years are left on your mortgage? How close are you to retirement? Does the $600,000 in CDs represent your complete nest egg? Since I don’t know your specific answers, I can only give you some broad guidelines to take into consideration.
Consider the real cost of your mortgage
You say your current mortgage is at 5.125%, but have you factored in the tax deductibility? Let’s assume you’re in the 35% tax bracket and your mortgage interest is fully deductible. In this instance, a 5.1% mortgage would actually cost around 3.3%. Almost a wash with the 3% you’re making on your CDs.
Factor in future investing opportunity vs. risk
As I’m sure you know, investments that carry the most potential for reward generally also have the highest risk. A CD is at the very low end of the risk/reward spectrum. So think about your comfort level. Would you prefer to invest your money in potentially higher-yielding investments? If you think you can do better than 3% and are willing to take the risk, perhaps paying off your mortgage isn’t the right decision.
On the other hand, current interest rates on CDs are very low right now. If you don’t want to increase your risk level and can’t match the 3% you’re making now as your CDs come due, taking the money and paying off your mortgage might make the most sense.
Determine your cash needs
It appears you’re in a very strong cash position, so liquidity may not be as much of a concern for you as it might be for others. A preference for liquidity might keep you from paying off a low-rate mortgage prematurely even if you can’t do as well or better with an alternative use of the money. Diversification could play a role here, too, as you look at your mortgage in light of your overall financial plan.
Evaluate your tax situation
Home mortgage debt remains one of the few sources of tax-deductible interest expense left to individuals who aren’t involved in a trade or business. IRS rules say you can deduct the interest expense on up to $1 million ($500,000 for married filing separately) of home-secured debt used to purchase or make capital improvements on your qualified principal and/or second residence.
You can also deduct the interest expense on up to $100,000 ($50,000 for married filing separately) of home equity debt secured by your home, whether in the form of a regular loan or revolving line of credit. Once you’ve paid off the original mortgage, you’ll be limited to the $100,000 home equity debt ceiling unless you make capital improvements or buy another home.
Because your current mortgage balance is $100,000, this may not be important to you. Also, if you have fewer than 10 years left on your mortgage, more of your payment is likely going toward principle than interest, so tax deductibility may not be a real concern.
Think about your peace of mind
For some folks, a strong desire to be debt-free overrides other considerations. There’s an emotional security in owning your home free and clear, and this seems to be especially true for those who are near or in retirement. If that’s the case for you, all other concerns may take a back seat.
As you can see, there isn’t one right answer to your question. It’s more a matter of the right balance for you. If the time you have left on your mortgage is short, if the tax deduction is not significant, and if you’re secure in the amount you have saved for retirement and less concerned about future investing opportunities, you may very well benefit from paying off your mortgage. As always, you should check in with a financial advisor for a more in-depth review of your personal situation.
Ultimately, it sounds like you’re in a good position no matter what choice you make.
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