I wrote about some things to think about when deciding whether or not to pay off your mortgage early a few months ago. My wife and I had a discussion about paying off our mortgage the other day (which rapidly deteriorated into planning a year long trip to Guatemala and going to see some Broadway plays). We were considering the merits of paying it off using three different techniques.
Why We'd Like To Pay It Off
We have over 14 years left on a 15 year mortgage fixed at 2.75%. After tax, that's about 1.84%. With 3% inflation, that's a NEGATIVE 1.16%. It's hard to argue mathematically that paying off a mortgage at a negative real interest rate is a smart idea. However, I'm pretty anti-debt and freeing up the cash flow required to pay that each month would allow us quite a bit of financial freedom (meaning I get to work two shifts less a month.) We never really planned on keeping the mortgage for a full fifteen years. We're still undecided about exactly when to pay it off. I'd like to pay it off by age 50 when I hope to have the ability to retire (12 more years) but it would also be nice to have it paid off by the time my eldest daughter starts college (9 years,) freeing up cash flow to help pay for that. Truth be told, I'd rather not have a mortgage right now, but have a very hard time throwing extra money at it if it requires passing up contributions to our HSA, Roth IRAs, Profit-sharing Plan, Solo 401K, Defined Benefit Plan, 529s, UGMAs etc.
Paying Extra Each Month
The easiest way to pay off a mortgage early is to just pay extra each month. I calculate that to pay off my now 14.5 year, $345K mortgage in just 9 more years requires me to pay another $1203 a month. That's probably not the smartest way to do it, however. First, it only earns me a return of 1.8%. Second, home equity isn't particularly liquid. It's tough to spend it on a trip to Europe if you change your mind about your financial priorities. Third, home equity doesn't get much asset protection in my state, not to mention if, for some bizarre reason, we defaulted on the mortgage and lost some of that equity to the bank.
Paying Off Our Other Mortgage
We have another obvious candidate for loan paydown. We have an investment property with a 5.3% mortgage. After tax, that's a 3.6% return, almost twice as much as the previous option. It isn't any more liquid or protected, but we plan to sell within a few years and would then have access to that money, which could either go toward our current mortgage as one lump sum, or used in another manner. We're already throwing $300 a month extra at this mortgage.
Taxable Investing Account
A better option in my opinion, although markedly more risky, would be to invest that $1203 a month into tax-efficient stock index funds in a taxable account. Lots of people worry about taxes when investing in taxable accounts. I don't. It's easy to find a tax-efficient investment. $100,000 invested in a total stock market index fund kicks off less than $2000 in distributions a year, which are taxed at only 15%, or about $300 a year. If the value of the investment goes down, I can tax-loss harvest it, offsetting up to $3000 of my regular, highly-taxed earned income each year. I also never pay capital gains taxes on the gains, as I can use highly appreciated shares for my annual charitable giving instead of cash. In this manner I can continually update the basis on the investment, effectively eliminating capital gains taxes on its eventual liquidation. So if my investment earns 8% a year, I'm going to get pretty close to 8% a year even after the tax man gets his cut.
It will take me 9 years to pay off the mortgage directly with that $1203 a month extra payment, but if I use the taxable account instead and earn 8% a year, I should have a lump sum sufficient to pay off the mortgage 11 months earlier. Best of all, I have the flexibility and liquidity in case I don't want to pay off that mortgage. I can always use the money on something else. I also have the ability to time my withdrawal of that money. If we're in a bear market 8 years from now, I can just hold the investment for another year or three until recovery. If, like now, we're 4 years into a bull, we can cash it out and pay off the mortgage. If the investment performs better than 8%, then I'll get there sooner. It would have to perform much worse than 8% (worse than 1.8%, or at least 3.6%) in order for me to come out behind using this strategy. While possible, that's probably not very likely.
Do you plan to pay off your mortgage early? What strategy will you use? Comment below!