The Mortgage Pay Down Decision

Debt-free home ownership is a long held financial goal for many Americans. New homeowners are ingrained with the rule you must pay down your mortgage as soon as possible. And, paying off the mortgage is typically a high priority goal for most retirees. But, with the thirty-year mortgage rate under 4%, is the conventional wisdom of accelerating the pay down of your mortgage the best idea right now?

Opportunity Cost. One way to determine if paying extra on your mortgage is a good idea is to determine the opportunity cost of investing it instead. Investors with growth strategy portfolios have expected annual investment returns between 8% and 10%. If you could have earned 8% - 10% investment income instead of saving 4% interest expense on your mortgage, investing would have yielded a higher benefit than paying down the mortgage. However, very conservative investors have lower expected annual investment returns, typically between 4% and 6%. In these cases, there is little, if any, difference between the potential investment income and the interest expense savings of accelerating the pay down of the mortgage.

Tax Implications. Many people justify large mortgage loans with the tax write-off, and while certainly helpful in lowering your tax bill, it is not the case in all situations. When evaluating the tax benefits of mortgage interest, it is important to compare the incremental tax deduction above and beyond the standard deduction you would have received without the mortgage anyways. For example, a married couple receives a standard deduction of $12,600 and only if the mortgage causes itemized deductions to be more than the standard deduction amount is the mortgage worth carrying for tax benefits alone.

It is also important to remember only interest and real estate taxes are deductible, not the principal portion of your payment. Payments in the last few years of a mortgage are primarily made up of principal payments and the deductible interest expense can be very low relative to the early years of the mortgage when the payments have a higher portion of interest expense.

Being debt-free is a liberating feeling and is usually an important step for financial freedom, but there are other factors to consider such as opportunity cost and taxes. In addition, there are other situations when it does not make sense to pay down extra on mortgage, such as carrying higher interest credit card balances or forgoing free employer 401k match. Make sure to evaluate all your resources and competing priorities before accelerating lower interest mortgage debt.