Ask Carrie: Carrie Schwab Pomerantz - The Personal Side of Money

Paying Off the Mortgage: A Good Investment?

October 13, 2010

Dear Carrie,

My elderly, retired parents have a mortgage. They also have a stock portfolio. How can they decide whether to pay off the mortgage by liquidating a portion of the stock portfolio?

—A Reader

Dear Reader,

When I read your question, my first thought was about how much the world has changed. A generation or two ago, I'd say that many, if not most, homeowners had paid off their mortgages by the time they retired. But in today's world, I'm sure that many retirees (and those nearing retirement) are still making mortgage payments—which makes this a particularly interesting question.

Basically, you can look at this situation from two perspectives—financial and emotional—and probably, the answer will depend on both.

The Benefit of Paying Off Debt
By "financial," I mean running the numbers to see if paying off the mortgage is a good investment. In a way, paying off or paying down debt is like a risk-free, guaranteed investment with a yield equivalent to the interest rate. Say your parents owe $100,000 on their house, and their mortgage rate is six percent. Eliminating that mortgage could be viewed as an investment with a return of 6 percent (the return could be slightly lower if your parents derive any benefit from the mortgage interest deduction). And if your parents have an older, higher-rate mortgage, their return would be even higher. It's difficult to imagine a prudent, safe investment that could offer six percent right now. Just as an example, according to Bankrate.com, the national average rate for a five-year jumbo CD—$100,000 or more—is under 2 percent.

At the same time, paying off the mortgage would cut their monthly out-of-pocket costs considerably, reducing their need to tap pension, Social Security, or investment income.

Of course there is always a trade-off with investment decisions. If you invest in cutting debt, then you have less money to invest for growth or income. So the next component of your decision is to consider what your parents might do with their portfolio.

I'd want to know first about how much they have in stocks and how aggressive (i.e., risky) is their exposure. You describe them as elderly, which triggers the questions: How much equity exposure do they need at their stage in life? How much risk should they be taking? (If you, or they, aren't sure of the answers to those questions, a good financial planner could help.)

If your parents believe that their portfolio will earn more than 6 percent (or whatever their mortgage rate is), the financially smart choice would be to keep the mortgage and hold on to their other investments. But of course that’s hardly a sure thing, especially with today's lackluster markets where single-digit returns are considered very good.

Of course I don't know all the details of your parents' situation, but it seems that paying off the mortgage could be an excellent way for them to reduce their risk, and significantly reduce their monthly expenses.

The Value of "Money in the Bank"
On the other hand, all of us need to have some money in the bank for the proverbial rainy day. So the decision also is a matter of proportion. As an example, if your parents have a $250,000 portfolio and a $100,000 mortgage, it might not be prudent to deplete their assets by 40 percent. But if they have $1 million in assets, paying off a $100,000 mortgage is more likely a good use of their money.

The Emotional Side
And then there’s the psychological side of this decision. Having money in the bank (or in the markets) can be reassuring, of course, but being mortgage-free might also give your parents considerable peace of mind. Only they know which is more important

But before you decide, run the numbers and talk with your parents about the pros and cons of both possibilities. At the end of the day, you might find that a halfway solution feels best. By refinancing to a lower balance (and potentially getting a lower interest rate), they could reduce their monthly expenses while retaining some capital for investments or for their nest egg.

As is often the case, there is no absolute answer; personal financial decisions are almost always about trade-offs and the specifics of each case. Help your folks understand those issues, and you’ll be able to make the best decision.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction and investment strategy for his or her own particular situation. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

(1010-6516)



The information on this website is for educational purposes only. It is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

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