Pay off Mortgage Early or Save for Retirement? Which should be a future early retiree’s priority? There are a lot of opinions on this question. It was one I had to deal with before reaching financial independence and becoming a Leisure Freak. On one hand if you talk to anyone who has retired without a mortgage they will say it’s the best move they ever made. On the other hand people who are confident investors will say that you can easily make more on your money. More than the low mortgage interest rate you are saving with a payoff. To decide on this issue there are some details that have to be assessed.
Mortgage Interest Tax-Deduction.
One of the attractive aspects of home ownership is the mortgage interest being tax-deductible. When you first start a mortgage you pay more in interest each month. That is a part of how they calculate the amortization repayment. But as time goes by and you pay down the principle the interest amount is less. That then decreases the tax benefit. You can only take the deduction if you can file your Federal taxes long form using the form 1040 Schedule A.
I Eventually Lost My Tax Deduction
Initially for me, the mortgage interest I paid along with all my other qualified deductions did cut my tax obligation. However as time went on the tax benefit decreased. At the same time the Standard deduction (short form) keeps rising. So financially speaking if you pay off a mortgage at 4.5% and are no longer able to take the tax deduction you are locking in a rate of return of 4.5% for the number of years you still have on the loan. The good news though is you don’t have to pay taxes on the equivalent 4.5% assumed payoff gain.
If you were still able to take tax deductions and lost them with payoff. This tax-free assumed gain would be a wash. However, if you had invested the money instead of paying off the mortgage you would more than likely have capital gains taxes to pay. Or eventually income tax if you invested the money in a 401K or IRA. I believe over the long-term the investment gains should be more than enough to exceed the mortgage payoff gains. Especially if we are including any employer 401K match you might be getting if you were in that situation. Any mortgage tax benefit is unique to someone’s personal financial situation. I took a lot of time going over my numbers to make my Pay off Mortgage Early or Save for Retirement decision.
You can refinance for a lower interest rate and a lower house payment.
I always liked the option of making extra payments on my own instead of locking into a 15 year mortgage and a higher payment. I always elected to go the 30 year mortgage route. I refinanced my house a few times. When I purchased the home in 1995 my mortgage was at 8%. I refinanced just before I retired at 4.5%. I then refinanced again two years later in 2012 at a 3.75% rate. I was paying $1185 a month including taxes and insurance in 1995. In the end I was paying for the same house $744 a month. Although the mortgage terms were pushed out another 30 years with each loan. They were all at a lower mortgage balance.
You can’t eat home equity.
I always thought. What if something happened before I reach what I considered financial independence and I needed money? Certainly I could refinance and take back some of that equity out in the loan. But the universe is a funny place. When you really need money, no one is willing to lend it to you. I did have a 2nd mortgage equity line of credit established for $25,000 of which I kept at a zero loan balance. It was for any large emergencies. But I always kept thinking it would be better to have more liquid investments in the event the worst happened. You can’t just make a phone call or go to the internet to sell your house or refinance it immediately.
Pay off the Mortgage and have more money to invest.
Whatever strategy used to save and pay off the mortgage. Once you do pay it off you now have more money to save and invest. Something about this really nagged at me. I just couldn’t stop thinking that you end up playing catch up. Because you lost what was probably years of compounding investment gains on the extra money diverted to your mortgage. However, I was really second guessing that thought in 2008 and 2009 when every investment including home values were in the toilet. I thought I should have paid off the house. But we all know how things have gone since then and it all can happen again.
My Decision.
After taking everything in, I concluded my priority should be to reach financial independence so that I could retire early. I included in my early retirement budget my monthly house payment. Because I have always planned on living a retire early and often lifestyle (a little like semi-retirement) with a passion-driven mindset, my strategy was to get the lowest mortgage payment that I could through refinancing. Then pay off the mortgage when my mortgage tax benefits ended and I had the cash or income to do so.
I was able to retire the first time with a mortgage and a budgeted house payment of $885 a month. I took a high paying position that I had long wanted to do and ended up refinancing for a lower interest rate and to a $744 payment. Because I live off of my retirement money I then dedicated 100% of my take home salary to the mortgage and it was paid off within 18 months.
In Conclusion
I don’t think there is a “one answer fits all” solution when it comes to Pay off Mortgage Early or Save for Retirement. Everyone will have to look at their own risk tolerance and assess all if any of the tax benefits of keeping the mortgage. It comes down to a numbers game and an emotional check.
Do you agree that I did it right or did I miss something? Any comments would be appreciated.