Should I Pay Off My Mortgage?

Should I pay off my mortgage early?

–Dave, Maryland

Under the right circumstances, homeowners should plan to pay off their mortgages early by making extra payments against principal. You don't have to start doing it now; the time may not be right. But on the other hand, do you really want to spend 30 years paying off your mortgage? Here are the advantages and drawbacks.

Advantages

•  Paying off your mortgage early saves lots of money, because the total amount of you spend to pay off the mortgage will be less—and sometimes far less—than it would if you took the full 30 years. Even though your tax deductions would be reduced if you were to accelerate the mortgage payments, you'd still win financially. That's so because for every dollar of mortgage interest you pay, you save only a fraction of that dollar in taxes.
•  If you can pay off your mortgage by the time you retire or shortly thereafter, you'll need much less income to support yourself in retirement than people who are either renting or still making mortgage payments.

Drawbacks

•  If you're one of the very few who are in the highest tax brackets (your income is several hundred thousand dollars a year), the tax advantage of the mortgage-interest deduction may outweigh the advantages of making extra payments.
•  The extra payments reduce the amount of money that you have to invest or to meet financial emergencies.
•  If you could earn an average investment return in excess of the interest rate on the mortgage, making extra payments would not be as financially desirable as investing the money. That used to be pretty easy to do, but during the past decade, stocks have gone nowhere, thanks to the twin bear markets of 2000–2002 and 2008–early 2009. Also, most investors put at least some of their money in low-interest investments, such as CDs and money market funds. Putting some of the money that is earning very low, if not minuscule interest, into extra mortgage payments is unquestionably an advantage, since the interest rate on your mortgage is higher than the return you'd get on these investments.

But Wait, There's More

For many homeowners, the pros usually outweigh the cons. But here are two caveats to ponder before adding extra money to your payments:

•  If you're in the workforce, make sure you have contributed generously to the retirement plans available to you, including your employer's retirement savings plans and an IRA. While there are lots of financial benefits to reducing your mortgage early, tax-advantaged retirement savings plans offer better ones.
•  Make certain you've paid off all other higher-interest loans, including credit card loans and car loans. There's no sense in making extra payments against your, say, 6-percent mortgage while you've got an 11-percent car loan and 18-percent credit card balances.

Jonathan, what's your take on holding on to a mortgage for the sake of the tax break? If my mortgage is my only debt, should I try and knock that out and contribute less to 401(k)s until the house is paid off? Or do I really want to contribute the max (15 percent) to retirement and just make the monthly mortgage payment? I’m in my 40s, have 10 years left on my home.

–Elise, Washington, D.C.

We envy you. Even if you don't make extra payments, you'll be mortgage-free in your 50s. As I noted above, don't lighten up on your 401(k) contributions to pay extra on your mortgage. Contributing to retirement plans is a "use it or lose it" proposition. Since there are maximum allowable contribution levels for every plan, each year you forgo making a contribution is a year you can't make up for in the future.