Many clients ask me the question of whether they should pay off their mortgage or keep on making their monthly payments? There are at least two ways to answer the question. One way to answer the question is economically. The second way to answer the question emotionally. Some people would like to feel good that they do not have a mortgage payment. They need to remember that they will always have a mortgage payment. The question is whether we would like to reduce it to just one payment rather than two.
We often forget that the home is really owned by the state. If we fail to pay property taxes over three years, they will come and force us out of “their” home. So, the real question is whether we want to make one mortgage payment to the bank and a second one to the state. We can pay either one or two payments, but never zero. The good emotional feelings will always come short of reality.
The second way to answer the question is from the perspective of economics or finance. We need to remember that the cost of the home is the interest and not the principle part of the payment. The principle payment is a transfer of capital from one capital asset to another. It is not an expense. It is a transaction! The interest is an expense and except for the interest tax deduction, it is money gone forever. If I am paying three percent on a mortgage and my home is appreciating three percent, I get to live in the home economically free!
The math would be something like this. A $400,000 home appreciating at 3% would gain $12,000 of value. The same home with a $300,000 mortgage at 3% would cost the owner $9,000. That leaves $3,000 of net worth for just having your name on the title. The home appreciates the same amount regardless of how much of it you own. The extra money not transferred into the home keeps on earning also. Payments from work earning are always after tax. It may take $1.30 to reduce your mortgage by $1.00...state and federal taxes. Put the full $1.30 into your retirement plan and finish with a bigger net worth. If mortgage rates were six or seven percent, I would rethink my answer.
This is a hypothetical example and is not representative of any specific investment. Your results may vary.