Friday, July 29, 2011

To Payoff or Not To Payoff, That is the Question.

My wife and I spent a few days visiting a great friend, a single gal who is only a few years from retiring from a teacher’s position in a school district in Maryland.  She asked me—after a few glasses of wine—the one question that I hear all the time, “should I pay off my mortgage before I retire?”

This used to be the American Dream—to retire almost debt free—but with all the options that we have now, maybe it’s not so much today.  And so, the right answer is, it depends.

There are a ton of variables related to coming up with the right answer, and of course I won’t print her financial information here, but the things we discussed and that will make a big difference are, what kind of income will you expect to have after retirement, and what expenses can you anticipate—from where you sit today?

If you have recently refinanced your mortgage, so that it is in the 4-5% range; if you will retire with a good monthly income; if you will qualify for social security and medicare concurrently with your retirement; if you have some savings that can carry you through any lean times; if you are healthy and have a family history of longevity; then you might want to evaluate paying off your mortgage.

The real question is, is it smart to pay off the mortgage, and thereby eliminate the monthly housing expense, by spending real cash to do it?  And of course this presupposes that you will want to live there for some time and that the house is neither too big or too small, that it is in the part of the country where you want to stay, and that you can’t imagine there will be any expenses relative to the house that will come as a huge surprise over the next few years—like a new roof or the like, which might make you wish you still had your cash.

Here’s what I see as the most important elements of her situation.  What is the rate of interest she’s earning on her savings account compared to the rate of interest she’s paying on her mortgage? All other things being equal, if you are paying 5.5% for your mortgage and earning less than 1% on your savings, then your money would be better used by eliminating the mortgage.

But would using your cash to pay off your mortgage leave you with enough of a cushion to live on for the rest of your life (or until you decide to sell your home at some point and use the equity/proceeds to cover living expenses – if you should decide to do that).

Let’s look at these elements individually.

As for the interest rate comparison, it would seem pretty clear that using some of your savings to pay off your mortgage makes good financial sense. I’m basing this conclusion on the assumption that using some of that money to pay off the much higher interest rate mortgage (even after factoring in the income tax benefits of it) seems logical to me.

Probably the harder part of this decision is whether or not the cash left over (if you do pay off the mortgage) would be enough.  If your annual expenses are under control, the question to be answered is whether or not those expenses can be covered by the fixed income sources (retirement, social security, savings, and other income if any). If they can, then keeping a 6 month cash cushion may be sufficient (knowing of course that if push came to shove, you could sell your home at some point and get the equity back out of it to live on). On the other hand, if you would need to tap into your remaining funds to supplement your income sources, then the decision may not be so straightforward.

And then there are the conspiracy theorists who think the Administration and Congress may throw all of us a curve, and the value of the dollar will melt away.  But even if we suffer high interest rates and rampant inflation, the only real effect that would have on paying off a mortgage is that your savings will earn a higher interest rate, and the cash value of your house will go up.  There will be lots of other problems, but not in this example.

Any devaluation of the American dollar notwithstanding, after weighing the payoff decision, if you still aren’t comfortable with what to do, my opinion is  you should get with a Financial Planner and crunch some of the numbers specific to your situation. It will likely cost you a little bit to do that but the expense will be “short money” and may well be worth it in the end.

Dane Hahn is a real estate professional with Tarpon Coast Realty in Boca Grande, Englewood and Sarasota.  He can be reached at or 941-681-0312.

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