Should I pay off my mortgage early?
Have you ever noticed those metal eagle plaques that hang on some houses? Usually, you find them over the front door or the garage. These eagles, sometimes called “freedom flyers”, have historically signified that the home was free and clear from any mortgage. Nearly 40% of homes today are owned debt free and could sport a shiny brass eagle. However, is it the best financial decision?
For a moment, let’s just consider the math of the decision. It mostly comes down to the interest rate on the mortgage and your expected investment return rate. If your mortgage interest rate is 6% and your expected investment return is 10%, investing any extra money may seem like the better option.
However, this is like comparing apples to oranges. We have to factor in the risk that is inherent to investing. Paying down your mortgage is essentially “risk-free”. You have probably seen one of the interest savings calculators already. An extra payment of $500 each month on a $250,000 mortgage at 6% cuts the interest paid by $146,128 and shortens the term by over 13 ½ years. That’s a 6% return that carries essentially zero risk.
Investing always involves risk. Different investments carry different levels of risk, and a higher rate of return should be expected to offset the additional risk. To figure out how much additional risk an investment carries, we start with the expected total return and subtract out the risk-free rate. Typically, the risk-free rate is proxied by US treasury bonds but in this case, we should use our mortgage interest rate to have a true apples-to-apples comparison.
For example, if you have a mortgage interest rate of 6% and an investment with an expected return of 12%, the risk premium would be 6%. So, you have to ask yourself, is the risk difference between investing and paying your mortgage down worth only 6% per year?
For some people, investing instead of paying down a mortgage absolutely makes sense. Typically, if your mortgage rate is low, investing is more attractive. If you have a long time before retirement and can take on more investment risk, it’s likely more beneficial to invest.
For others, paying down a mortgage may be the best solution. If you have a high mortgage interest rate or are very risk averse you may want to consider extra payments.
One of the most common regrets that retirees have is retiring with debt. Looking past the math, there’s a huge emotional benefit to living in a house that is free from debt. When deciding what’s right for you it’s important to consider how you feel about having a mortgage and how you may feel if you didn’t have a monthly payment to make.
With my clients, I tend to put a premium on that feeling of safety and security. Even if it may not be the textbook “right answer”, at the end of the day it comes down to helping people create a life that they are happy to live. There’s no shame in wanting to pay off your mortgage, even if it’s just for the cool brass eagle.
