Should I pay off my mortgage if the cash is available?

Question

I have been making minimum payments for 14 years on a 30 year fixed mortgage with an interest rate of just under 5% and no prepayment penalty. I have about $105,000 principal balance, and stand to gain enough to pay this off and have around $20,000 left in the bank. I am leaning towards doing this but don't know if it's the smartest thing to do with the money.

For some background, I am in my 40s and have medical insurance through work and a couple of retirement accounts (this is not where the money in the first paragraph is coming from). I have no plans to sell my home in the American south, which got a new roof and HVAC system within the last five years. I don't itemize my taxes so I can't deduct my mortgage interest. I don't have any other debt and I'm able to save a bit after each month's expenses.

Does it make sense to pay off my mortgage now? Is the money better invested elsewhere?

Answer 1

This is one of those situations where you can't really make a wrong decision. Suboptimal, but either you are going to have 120K in the bank and a low cost mortgage; or 20K in the bank and a paid for home. Nice either way.

If your interest rate was lower, say like 3%, a case could be made for buying CDs with this money as the prevailing rate is right around 4.5%. But in order to play the interest rate arbitrage game with your mortgage, you would have to buy long term below investment grade bonds (5 to 10 year BBBs get you about 7%.) As this is risky, it is a clear choice between paying off your home or not.

If it was me, I would pay off the home if your life and budget is stable. This frees much income for things you want to do in life like invest, travel, or a hobby.

If it is less stable, maybe use half of the money to pay down the mortgage. This will slide you up on the amortization scale and more of your regular payment will be applied to principal. Once you feel more comfortable about your life you can just pay the thing off.

Keep in mind you will have to do your own escrow for taxes and home owner's insurance.

Contrary to your username, you are pretty special. Great job putting yourself in this financial position.

Answer 2

Don't underestimate the peace of mind that comes with having paid off your mortgage.

This means that even if your life takes a negative turn, (health or some other catastrophe), you have less expenses, and therefor less worry.

So yes, when I could, I did pay off my mortgage. It's a way to lower risk.

Answer 3

The is always a big debate about when to payoff the house. I am not going to wade into that debate.

There is one line that concerns me.

pay this off and have around $20,000 left in the bank.

That isn't nearly enough cushion. The general advice is to have 3 to 6 months expenses in emergency funds to survive a job loss. I have seen people find new jobs in a few weeks. I have seen others take a year. I would feel more comfortable if this number was closer to your yearly expenses.

Yes, if you are running out of money you can use your credit card at a very high interest rate. But being unemployed isn't the time to try to get a home equity loan, because they probably won't approve it.

This is even worse if the remaining $20,000 is all your money in the bank not just your emergency funds.

Answer 4

Nathan Lord Rothschild (the 1st English Rothschild) is supposed to have said, "The world is divided into two types of people, those who like to eat well and those who like to sleep well."

Thanks to good habits and good fortune you have put yourself in a position where day-to-day financial worries should not be keeping you awake. Make the decision that suits your risk tolerance. And keep in mind that your residence is not just another financial asset.

If I were you, I might accelerate my mortgage repayment (pay more principal each month). At present, you can earn close to your mortgage interest in very safe liquid securities (high-grade money-market funds and T-bills). That way you have your rainy-day-fund while hastening the day your mortgage is paid off. Should unexpected expenses arise, you're in good shape. And, should interest rates return to zero, you'll be in a position to pay off the balance if you so desire. (Should they rise, well-played!)

Having no debt is comforting. Having a nest egg is comforting. Having the choice is a not a bad problem.

Answer 5

What are you going to do with the money if you don't pay off the mortgage? If the answer is "invest it in something that I think will safely pay significantly more (after taxes) that the interest costs", that's the safest opportunity for leveraged investment you will probably ever have and you should let the mortgage run. If whatever you do with it would not produce those returns, you might want to pay off the loan.

Remember that after paying off your mortgage, you can, if necessary, take out a home equity loan. This will probably cost more in interest than the mortgage would have, but it does mean that you have some ability to recover if you have a need for additional cash.

Note that even so you do not want to be "house rich but cash poor." Ideally, you should always have the equivalent of 1 years worth of spending in an account you can quickly access such as CDs or a high interest savings account. Consider setting that aside before deciding whether to pay off your mortgage.

Remember too that there is the intermediate choice, assuming your mortgage permits it, of paying down the principal without paying off the loan entirely. This shortens the duration before the loan is paid off, and reduces how much the loan will cost you as a result. Depending on your confidence in your investments versus the loan's interest rate, this may be as good a choice as investing anywhere else. Maybe better, if your primary concern is safety. And it can be done incrementally in most cases, by making additional payments against the loan; check with your lender to make sure this is permitted and establish what the procedure is, or these May wind up as early payments rather than additional payments.

But you have to decide for yourself where you are most comfortable on this spectrum. We can't tell you; we're not you.

Answer 6

Frame challenge: Is this really an either/or decision?

My mortgage has the option to pay off any amount I want once per year. If your contract is similar, it means you can pay off half of the mortgage and keep the rest for a very nice rainy day fund.

If this is possible (if it's not in the contract, you can still ask the bank if they'll allow it) then you can check if maybe a middle ground is the best option for you.

Your advantage would be that in a fixed monthly sum mortgage, you are still paying a large amount to interest and only some to reduce the debt. Paying off parts of it also brings you into the region where more of your monthly payment goes towards debt than interest.

Answer 7

Using an online calculator, along with some adjustments to make the math simpler (I've worked on $100,000 instead of $105,000 and an interest rate of 5% as you said "just below 5%, hopefully these two estimations cancel each other to a certain degree) and with 16 years currently left, I guess you are paying approximately $750 per month. If this is ballpark correct, then over the next 16 years, you will pay somewhere in the region of $40,000 to $45,000 in interest alone.

There are definitely arguments about keeping cash in reserve for emergencies, however if you maintained your discipline and instead saved your $750 per month mortgage payment in to a 'rainy day fund', your left over $20k would be doubled in just over two years. Plus with no monthly mortgage payments to make, that emergency fund can stand to be smaller than usual.

Everyone's circumstances are different, but if I were in this position to make this choice in my fairly typical family situation, I would absolutely pay off the mortgage and get rid of probably my biggest monthly outgoing. Plus, outside of taking another job, I know of no other way I could possibly make that money save me $40k in interest alone with basically zero stress and no effort on my part.

Answer 8

I don't think there's a single perfect answer, based on what you've said, and I don't think you can provide enough information for random strangers to answer your binary question as to whether to pay off or not.

That said:

• You say, "stand to gain enough to pay this off and have around $20,000 left in the bank" . . . how? If you're getting a $125K windfall, that will affect your taxes.

• How is retirement looking? Are you on track to deposit the limit of $23K in your 401k? If not, consider doing that.

• There are many other factors. How much you make. Are you married. Are there kids. These are all part of the big picture.

• Another one. When will you ever need a new car? (Or a new used one, whatever.) Being able to buy a car without a loan will save you so. much. money.

• What's your mental game? Can you sit around with ~ $100K without blowing it on stupid stuff? This is a serious question. One person's stupid stuff is another person's raison de vivre.

I can tell you one thing, once you pay off the mortgage, getting the money back out will have a transaction cost.

My advice:

Once you get this windfall, find some high-yield savings account to stick the money in, then look at your complete picture. Educate yourself as you need to. Take a month if you need to. If you're the reading type, consider some of the books great books on the subject. Then make a decision. That way you're making a decision from a place of strength, not just throwing a dart at a dartboard.

If in fact you're getting a windfall of some sort, you might find this Reddit post useful:

https://www.reddit.com/r/personalfinance/wiki/windfall/

Answer 9

It depends on the interest rate you are paying on the mortgage and the interest rate you receive on the cash if you don't use it to pay off the mortgage.

For example, you may have a 4.5% mortgage. In the UK you might get 5% on the cash, but the government will tax that interest at 20% or 40%, so really 4% or 3%. Conclusion: pay off the mortgage to save yourself 0.5% or 1.5% per annum.

If you had a 1% fixed rate mortgage for the next few years you would be better off not repaying it now, but holding on to the cash so you can redeem the mortgage instead of renegotiating when the fixed term runs out.

Also you need to allow for any early redemption penalty on the mortgage. Also you might not want to use up ALL the cash, if there is any significant chance that not having it will cause you to enter into credit agreements at much higher rates than an effective 0.5% or 1.5%!

If you elect to keep some of the cash and pay off some of the mortgage, do not under any circumstances save the cash with the same bank you have the mortgage with. If something goes wrong and you fall into arrears on the repayments, they can and will seize any cash balances you hold with them. If the cash is in another bank they cannot do this, and would have to get a court order, so you would have plenty of time to (say) find another job, or (worst case) run out of cash and file for bankrupcy.

Oh, and from experience, there is a huge peace of mind benefit that comes from owning your proprty free and clear of any mortgage. Thereafter, whatever life throws at you, you have a place to live.

Answer 10

I'm in the UK, so can't comment on USA specific considerations (of which it seems there are many) but the way I think about any financial decision is risk-weighted upside/downside. In your case you have two items to consider: the mortgage and the cash on hand. Your mortgage is near zero risk - you have a fixed rate which will not change unless a financial instutution goes bust and somehow the new institution is legally allowed to alter the terms of the mortgage. Very unlikely if not impossible. Your cash on the other hand can be put to use in a variety of ways. I don't know what US treasury yields are at the moment, but if they're higher after tax than your mortgage rate, then it makes sense to not pay it off. Anything giving you higher returns than US treasury bonds is (or rather, should be) higher than zero risk.

Personally, I find paying off the mortgage the simplest no-brainer solution, even if it might be suboptimal for a higher risk apetite and potential earnings - after you do that you still have 20k to play with, which isn't a large sum but definitely big enough to play with. Also, it doesn't need to be all-or-nothing. For example, you could decide to pre-pay 10% every year and invest the rest in instruments of choice that mature at the appropriate period and have the level of risk you're happy with.

Whatever you do though, do not sit on your cash. I don't know what the tax regime is like, but while you're working out what you want to do long term, keep it invested in low risk short term instruments. You can even start a higher risk higher return investment for the 20k that you know will not be touched by your mortgage payment no matter what your eventual decision will be. And if you do see a US treasury rate spike, make use of the opportunity to buy as much as you can. It will outperform cash no matter what.

Answer 11

This is a fairly common dilemma. At the end of the day it comes down to personal preference, and your level of comfort with financial risk.

One common approach from the Bogleheads website recommends prioritising as follows, in order to maximise the expected reward/risk ratio:

1. emergency fund
2. employer matched retirement plan
3. high interest debt (credit cards)
4. health savings account (US specific)
5. IRAs and other tax-advantaged retirement plans (partially US specific)
6. medium interest debt (student loans, car loans)
7. taxable investments
8. low interest debt (mortgage)

If you agree with this prioritisation, you would hold off on repaying the mortgage, and instead use the money for one of the higher priority buckets. If you prefer the minimum possible level of risk, then paying off the mortgage will be better for your peace of mind.

Answer 12

It depends massively on HOW your interest is charged on the mortgage and their rules for draw-downs.

If it is charged on the remaining outstanding balance, AND you have an ability to "draw-down" on the mortgage then I recommend doing what we have - pay just shy of paying off the entire mortgage.

That gives you a cushion of being able to draw on the mortgage as an effective savings account.

Instead of paying tax on interest gained on savings, you're effectively getting the full benefit of the mortgage rate.

Answer 13

The rules of wealth management I see relevant to this question are two:

1. If you can obtain money in advance, always take it.
2. Never let money lose its value by keeping it stagnant, it must always work for you, generating returns.

So, combining the two, my considerations are:

• you have cash available in advance, but
• if you have an open mortgage, the real money you owe is the balance between the mortgage outstanding and your available cash, therefore
• you are paying interest on the mortgage to keep this balance in your availability, so
• you should invest the cash to earn returns that are at least higher than the mortgage interest.

Answer 14

Others have questioned whether $20,000 is enough of a cushion.

First, think about why you save in the first place. Here are a few things I can think of (and I'm probably missing a few):

• Irregular expenses (e.g. annual subscription fees)
• General goals like retirement
• Specific things you want to purchase (such as vacations)
• Large expenses that you can easily anticipate, such as car repairs, car replacement, home repairs, etc.
• Unexpected expenses (i.e. an emergency fund). The usual recommendation for this is to have 3 - 6 months of essential expenses. Note that I specifically said essential expenses (not "expenses"). So, for example, if you lost your job, you wouldn't necessarily need to save money to eat out every week, but you would need to be able to cover things like medical expenses, insurance premiums, gas for your car, etc.

So, you need to make sure that $20,000 is enough for those. Calculate your essential expenses. Also consider things like upcoming car repairs, vacations, etc.

That being said, I would like to point out that you don't need to pay off your entire house - you can, for example, pay off all but $10,000 and still have $30,000 in savings, or pay off all but $20,000 and still have $40,000 in savings. You'll still likely save tens of thousands of dollars in interest payments by doing this.

I can't tell you exactly what the right amount is (because it depends on the amount you need for the items listed above).

Answer 15

Yes you should, unless your income is guaranteed to a large extent.

All the calculators miss the fact that people tend to lose their jobs precisely when economy tanks. And in tandem. All too often, if there is a second income, it dies at the same time. But the mortgage continues.

So in reality, you may easily end up with a mortgage payment and unemployment benefits, and then no income and still mortgage payments continue.