Although we spend a large majority of our time planning our clients’ investment portfolios, we believe advising on the entire client balance sheet is just as important. On the liability side of the balance sheet, a client’s primary mortgage is often a major talking point. The last decade has allowed homeowners ample opportunity to refinance (sometimes multiple times) to lower interest rates. The ultra-low interest rate environment has provided a lift to home values and therefore home equity in existing owners. Because a refinance essentially restarts the clock on a new loan, we have noticed a number of clients who have come to us with loans that are scheduled to be paid off well into the clients’ retirement years. For a handful of our clients who have substantial retirement cash flow and also believe in the leverage a mortgage provides (borrow cheap, invest to make more), we have supported the idea of carrying a mortgage into retirement. For the large remainder of our clients, we believe having a paid off home at retirement (or earlier) creates value and opportunity in a number of other areas.
1) Saves a Lot of Interest
The most obvious reason to pay off a mortgage earlier is that the total interest cost is substantially less. Take a $300,000 first mortgage at 4% amortized over 30 years. The total interest paid over the life of the loan is just over $215,000. If that same loan and rate were paid over 15 years, the total interest cost is just over $99,000.00. The term was halved but interest savings is well over 50%.
2) Trick Yourself Into Living on Less
For people who have experienced wage increases, shortening your loan is a great way to utilize this improved cash flow. We have advised a number of clients to refinance into 15-year loans from 30-year loans as a reaction to better cash flow. People’s lifestyles have a way of naturally absorbing extra income and this is a great method to put that cash flow to good work. The net result is a loan paid off quicker and a bonus in cash flow when the loan is paid off.
3) Future Goal Funding
Retirement is the primary goal for most investors, but many of our clients have expressed other major goals like funding a child’s or grandchild’s education, buying a vacation home, or starting a business. We have found it very helpful to pair the scheduled mortgage payoff before these other goals begin. With extra disposable cash flow created from no longer having a mortgage payment, most goals become much more attainable and less risky to pursue.
4) Peace of Mind
If paying or not paying off a mortgage was all about the math, we would all own fully-mortgaged homes and invest every penny we save by not paying early. We tend to take the opposite approach with our clients. I can unequivocally state that there is no greater financial burden lifted than when someone pays off their home. As well, we have advised countless clients to pay off their home (often well in advance of their original plan) and we have never had someone regret the decision. We live in a world where information (often troubling) and uncertainty circulates quickly and haphazardly, and we have noticed a “peace of mind” that settles over our clients when they can add stability to their own situation through a mortgage payoff. There is no better example of a financial planning tactic where the value is not ever fully represented in the numbers.
5) Future Flexibility
I am always surprised by the number of people who plan to “downsize” when they retire, utilizing the equity they have accumulated in their existing home for their new home. For those people who have not paid off their home, they soon realize that “downsize” doesn’t necessarily mean lower cost. With added amenities or a warm-weather location, retiree home buyers have been discovering that they often end up spending similar amounts, if not more, for their next home.
We do not look at your home as an investment. Although most of our clients have experienced some amount of wealth creation from home ownership, there are far too may expenses and unknowns to treat it as such. We believe the safest approach is paying the home off earlier than scheduled and not depending on the home’s equity for future needs. If handled in this manner, the paid off home and resulting home equity create a “financial cushion” to you and your survivors that cannot be adequately measured on a balance sheet.