05 Dec Why Paying Off Your Mortgage Early Might Not Be the Best Financial Move
In today’s world of personal finance advice, it’s not uncommon to hear financial influencers, bloggers, and gurus encouraging everyone to pay off their mortgage as quickly as possible. The mantra of “debt is bad” is often preached, with many financial personalities touting the peace of mind and financial freedom that come with being mortgage-free. This is further compounded by the way many of us were raised—our parents taught us that debt is inherently bad, and the sooner we rid ourselves of it, the better. Even worse, some of us were even taught that debt is morally wrong.
So, it’s understandable why so many people are eager to pay off their mortgages early, especially for those who have the financial means to do so. But while this advice seems intuitively sound, it often overlooks key financial principles that could be more beneficial in the long run, particularly for those in a position to take a more strategic approach. In fact, for individuals with a relatively low mortgage rate—such as 3.5% or lower—it might not always be the best decision to rush into paying down your mortgage.
Here’s why focusing on other financial priorities may actually be a smarter move:
1. Opportunity Cost: The Power of Investment Returns
One of the primary reasons to avoid paying off your mortgage early is the opportunity cost—the potential investment returns you could be missing out on. If your mortgage rate is 3.5%, it’s likely, if you have a long-term investment horizon, that you can earn a higher return by investing that money elsewhere.
For example, investing in a diversified portfolio of stocks, bonds, or real estate may yield returns far exceeding 3.5%. Historically, the stock market has returned an average of 7-10% annually over the long term, well above your mortgage interest rate. Even guaranteed savings account rates are a full 1% higher at the time of this writing! By choosing to invest your money rather than use it to pay down your mortgage, you can leverage the compounding effect of returns, significantly growing your wealth over time.
2. Tax Benefits of Mortgage Interest
For individuals who itemize deductions, the interest paid on a mortgage can be tax-deductible. Although recent tax reforms have reduced the number of people who benefit from this, if you’re in a high tax bracket, paying mortgage interest can still provide significant tax advantages. By maintaining a mortgage, you effectively reduce your taxable income, which can be a key part of your overall tax strategy.
For instance, if you’re paying 3.5% interest on your mortgage, and you are in the 37% tax bracket, your after-tax interest cost is reduced significantly. This can make the cost of holding a mortgage much lower than it initially appears, freeing up capital for more strategic investments.
3. Liquidity and Flexibility
One of the often-overlooked advantages of carrying a mortgage is the liquidity it provides. By not using all your available cash to pay off a loan, you retain more flexibility in your finances. This liquidity can be essential for managing personal expenses, making opportunistic investments, or funding other financial goals, such as growing a business, supporting philanthropic endeavors, or taking advantage of market opportunities.
Having a mortgage means you don’t tie up your capital in an illiquid asset (your home). If your funds are instead invested in liquid assets, you have greater freedom to access them when needed. Sure, you could get a loan against your home if you need cash, but you’re subject to credit worthiness, current interest rates, and the time it takes to apply.
4. Inflation Erosion of Debt
Another benefit of carrying a low-interest mortgage is the effect of inflation. Over time, the value of money decreases due to inflation. When you hold a mortgage at a fixed rate, the amount you owe remains the same in nominal terms, but the real value of that debt declines.
If inflation averages 2-3% annually, your mortgage payments become cheaper in real terms. This is especially advantageous when you are earning a higher return on investments or when the value of your assets increases faster than the rate of your mortgage. Essentially, you’re using “cheaper” money to finance your home while potentially seeing your net worth grow in more productive ways elsewhere.
5. The Psychological Appeal of Leverage
While the concept of leverage can be daunting, it can also be a powerful tool in wealth accumulation. By keeping a mortgage, you are leveraging Other People’s Money (the bank’s) to maintain ownership of your home. If you’ve been around a while, you know we love investing with OPM! Instead of using all of your funds to pay down the mortgage, you can deploy that capital in ways that offer higher returns, such as investing in stocks, real estate, or other assets that grow your wealth.
This approach is particularly attractive when the cost of borrowing (i.e., the mortgage interest rate) is low. By using leverage wisely, you maximize the efficiency of your financial strategy. For high-net-worth individuals, employing smart leverage can enhance returns without taking on undue risk.
6. Passing On Wealth to Your Family
When people plan for the future and how they want to pass on their money or property to their kids or grandkids, keeping a mortgage might actually help. If you pay off your mortgage early, you’re taking away some of the cash money that could be passed down to your family. But if you keep the mortgage, you can leave behind more cash, investments, or other things your family can manage and use in the future.
7. Psychological Factors and Financial Peace of Mind
For some people, the idea of carrying a mortgage, regardless of the financial reasoning, may cause undue stress. The peace of mind that comes with being debt-free can be invaluable. However, for high-net-worth individuals, it’s important to weigh this against the financial benefits of investing that money elsewhere.
A tailored financial strategy can include maintaining a low-cost mortgage balance while focusing on growing wealth through other means. A diversified approach allows for both the emotional comfort of paying down debt and the financial benefits of retaining it.
Conclusion
While there’s no one-size-fits-all answer to the question of whether or not to pay off a mortgage early, for many of us, keeping a low-interest mortgage may be the more financially savvy choice. The ability to invest that money for potentially higher returns over the long-term, take advantage of tax benefits, preserve liquidity, and benefit from the erosion of debt due to inflation are all compelling reasons to avoid rushing to pay off a 3.5% mortgage.
As with any financial decision, it’s important to carefully consider your overall wealth strategy, goals, and risk tolerance. Your Wright Wealth CFP can help you determine the best approach for your unique situation, ensuring that you make the most of your financial resources in both the short and long term.
Information is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products, or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.
The commentary in this post (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of Angela Wright, an Investment Adviser Representative of Gemmer Asset Management LLC (“GAM”) and should not be regarded as the views of GAM, or a description of advisory services provided by GAM or performance returns of any GAM client. References to securities or market-related performance data are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. The information presented herein may contain links to third-party websites with which we have no affiliation. A link to any third-party website does not mean that we endorse it, or the quality or accuracy of the information presented on it.