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Should I Pay Off My Mortgage?

Let's first go through the benefits of paying down versus maintaining a mortgage.

The Benefits of Paying Down a Mortgage

Let's start with the benefits of paying off a mortgage - either by taking a lump sum of funds to pay down principal, or by sending in extra principal payments. First, making extra principal payments is a form of forced savings. If you were not making the extra payments, would that same money get saved? If not, then it is best to make the extra mortgage payments. Second, pre-paying mortgage principal will guarantee you a return equal to the mortgage rate (ignoring some adjustments for taxes). Therefore, if the funds were going to sit in cash earning 0.2% anyway, why not send them to the mortgage company to get a higher guaranteed fixed rate? Finally, paying off a mortgage feels good. It feels liberating and freeing.

 

The Benefits of Maintaining a Mortgage

First, a mortgage provides "positive financial leverage". This is the ability to borrow at one rate (the mortgage rate) and invest at another (by using your money for investment rather than mortgage pre-payment). In other words, if you were NOT making mortgage pre-payments and you were to instead keep the money invested at a rate higher than the mortgage-interest-rate (over the life of the mortgage,) then you come out ahead in the long-run. Borrowing money at 3.5% and investing it at an expected long-term rate of 7.5% provides a 4% advantage over the long-run (with some risks). Second, a fixed mortgage allows you to maintain a low rate as mortgage rates rise, but also allows you to refinance at an even lower rate if mortgage rates drop. Third, maintaining a mortgage provides some cash flow flexibility in the event of job loss/disability due to the funds remaining liquid and are NOT locked up in home equity. Fouth, a mortgage allows diversification. Who is better diversified - someone with a $400,000 home (no mortgage) in a single neighborhood/city, OR someone with the same $400,000 home, but because they have a mortgage of $250,000, they are able to maintain a $250,000 globally diversified portfolio? Finally, a mortgage provides some inflation protection. In the event of inflation, your salary rises and the loan value "shrinks" (in real dollars) due to the effects of inflation.

 

Should You Pay Off Your Mortgage?

To simlify, if your interest rate is low and your risk level is moderate/high, it is far better for your long-term financial security to maintain your mortgage and invest the dollars you would otherwise send to the mortgage company as pre-payments. If you are financially independent or risk averse and would feel great getting rid of your mortgage, go ahead and pay it off.  

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