Why You Should Own Your Own Home Free and Clear

Friday, July 30th, 2010

From my experiences over the last couple of decades, I’ve observed that folks tend to have a less stressful and more worry free retirement when they don’t have the burden of debt in their life. Which is why I believe your ultimate goal should be to own your home free and clear at or before retirement. But occasionally, I get challenged on that concept on one of two fronts.

The most common objection to paying off a mortgage that I hear is, “Wow, if I do that I’m going to lose valuable tax deductions.” Well, I just have trouble understanding how that truly makes sense. And here’s what I mean by that. If you think about it, if you pay mortgage interest, for every $1,000 dollars of interest you pay, you’re going to save $150 – $400 on your taxes. Well what would you think of someone, maybe someone like me, suggesting you put $1,000 into an investment knowing that it’s only going to return somewhere between $150 and $400?

Yeah, your taxes might be going up if you don’t have mortgage interest to claim as a deduction. But what a lot of folks leave out of their thought process is net cash flow, because you also are eliminating a mortgage payment.

If you want to see an example, in my book ‘Worry Free Retirement’ I wrote about someone that paid off a $320,000 mortgage. This person obviously lost a huge tax deduction on the mortgage interest — and yet they were ahead of the game every year by almost $10,000 in net cash flow. So to me the “my taxes are going up” argument doesn’t hold water.

The other objection that we’ll hear from time to time is that, “Mortgage money is cheap. Why shouldn’t I just keep my mortgage and keep the money that I would have used to pay the mortgage off invested in a higher returning investment? Then the difference, or the spread, is mine to keep.” For example, if you have a 5% mortgage and earn 8%, you’re making a net 3% on your mortgage balance. In theory, this makes sense. But that theory has some holes in it.

The challenge is, when you have a mortgage, you have guaranteed a fixed interest rate for a fixed period of time to the bank. So if you’re going to play the investment arbitrage game, I think you’ve got to play the game like the bankers do. So you have to get a return that’s at least 2% higher than what your cost of money is — and that return needs to be guaranteed. After all, you’ve guaranteed the rate you’re going to pay the bank!

Here’s the catch — it needs to be guaranteed for the same amount of time that’s remaining on your mortgage. Now, you might be able to find an initial rate guarantee on some other investment, but at the end of the day, the rate is probably not guaranteed for the same length of time remaining on your mortgage. To me, this is an apples-to-apples comparison on the investment arbitrage. Anything less leaves you accepting an increased level of risk…one that your banker isn’t taking, so why should you!

The one exception when it comes to paying off a mortgage is that in a perfect world, you accumulate money outside of a tax deferred account like an IRA or a 401K and you would use that non-IRA, non-retirement money to pay your mortgage off. After all, if you pull money from an IRA or a 401K, that money is going to be taxable as ordinary income to you.
Depending on your age, there could be another 10% penalty tax, which could increase the cost of paying off your mortgage by roughly 20-30%. So if you have enough non-retirement money available, we think it makes sense to seriously consider using some of it to pay off your mortgage and own your home free and clear.

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