The Mortgage Dilemma: To Pay Off Early or Not

When we sit down with new clients to begin building their financial plans, we are often asked our thoughts on paying off a mortgage early. However, like many financial decisions, there isn't a one-size-fits-all answer. Whether you're driven by the goal of being debt-free, lightening financial loads before retirement, or simply seeking peace of mind, each choice carries its own trade-offs. To determine if paying off your mortgage early aligns with your financial strategy, weigh the following considerations:

Cash Flow

Before contemplating additional mortgage payments, it's crucial to maintain robust cash reserves. We typically advise having a cushion equivalent to at least six months of living expenses to safeguard against emergencies or unexpected job loss. Cash remains the most immediate resource for meeting family needs and settling bills. Funds invested in a property, on the other hand, lack liquidity and offer limited flexibility.

Free Money

Before considering extra mortgage payments, prioritize maximizing contributions to your retirement accounts, particularly if your employer provides a match. This match is akin to earning 'free money' and accelerates the compounding growth of your savings. Additionally, funding your retirement accounts offers tax benefits, potentially decreasing your taxable income for the present or future years.

Other Debt

You’ll also need to assess your existing debts before contemplating extra mortgage payments. Credit card debt typically carries substantially higher interest rates, so paying off such high-interest debts before directing funds towards your mortgage.

Opportunity Cost & Compounding

Opportunity costs represent the potential benefits that an individual, investor, or business misses out on when choosing one alternative over another. Suppose you have both a 4% mortgage interest rate and an investment account with a local advisor. If you opt to direct an extra $10,000 to your mortgage instead of the investment account, your opportunity cost hinges on the potential returns from the investment. Should your investments consistently yield more than 4% annually, then the extra mortgage payment essentially sacrifices potentially higher returns. While a few percentage points might appear minimal, over time, they can significantly affect your financial independence, potentially forcing you to work for a few more years. For instance, assuming you could earn an 8% return on your investments, that $10,000 could surpass $100,000 in thirty years. This far exceeds the interest saved on the mortgage, illustrating how optimizing low-cost debt can augment wealth.

If you've fully funded your retirement accounts, settled your high-interest debts, and established both a solid cash reserve and an emergency fund, then prioritizing your mortgage worthwhile objective if it aligns with your long-term goals. Financial planning decisions like these are only a small part of your financial plan, and should not be looked at piece by piece, but as a part of the big picture. Consult with a trusted financial planning professional when considering what options would be best for you and your financial plan.