If I put all our clients into two groups, those with mortgages on their homes and those totally debt free including no mortgage on their home, guess which group slept better at night and wasn’t as stressed or worried during the latest bear market?
Now you know why I encourage you, as well as all of our clients, to own your home debt free at or before retirement.
The most common objections I get to this line of thinking are twofold. First, the loss of tax deductions meaning higher income taxes, and secondly the ability to have more of your money invested at potentially higher returns compared to the interest rate you pay on your mortgage.
So let’s debunk both of those myths right now.
LOST TAX DEDUCTIONS
For years I’ve offered a $10,000 reward to anyone who could explain to me how getting rid of a mortgage is going to cost me money. The popular (but inaccurate) argument is you’ll pay more in income tax because of the lost interest deduction. So here’s my question, worth $10,000 to the first person who can give me a logical answer:
How Do You Make Money When You Give Away $1 Of Interest To The Mortgage Company And In Return Receive .15 -.35 Back From The IRS?
Anyone who keeps a mortgage to keep their taxes lower is running this race in reverse. How long would you keep your money invested in a stock or a mutual fund if for every dollar invested all you got back was .15 – .35?
Still not convinced, that’s okay everyone’s situation is different. You should do some number crunching on your own situation. Be sure to add the increased cash flow you’ll receive from not having to make mortgage payments. This is the key factor everyone leaves out!
I Can Invest At Higher Rates Compared To What My Mortgage Is Costing Me
This is the other argument I hear all the time. Why use investment capital that could be earning higher returns to pay off a lower interest rate mortgage? The mistaken logic here is that you’ll be able to earn investment returns on a guaranteed basis that are higher than your mortgage interest rate.
What’s that you say, you know the investments you have don’t guarantee future performance, but hey the last 10-15 years have been pretty good. Sound familiar? Then you’re comparing apples and oranges. Make sure you compare apples to apples.
Here’s what I mean; your mortgage has a guaranteed interest rate you’re committed to pay the bank. Doesn’t it then stand reason that you should invest in other investment accounts that provide guaranteed returns? Those returns should be at least 2% higher than the interest rate on your mortgage.
That’s the way most banks operate, when they make loans to other people the interest they charge is at least 2% (usually a whole lot more) higher than the interest rates they are paying their depositors (i.e. Money Market accounts and CDs). So don’t fool yourself, you’re not improving your financial situation by keeping your money invested in other investments unless they are guaranteed investment accounts paying you at least 2% more than the interest you’re being charged on your mortgage.
I have yet to find anyone who is able to find these types of investments on a guaranteed basis. Sure you can find lots of stocks or mutual funds that have provided 2 or 3 times the return compared to mortgage interest rates. The problem is, they don’t guarantee these returns will continue now and into the future.
Don’t get suckered into an annuity either. While they may provide an initial rate guarantee that’s higher than your mortgage rate, none of them will lock in that guarantee for the life of your mortgage! Most will also hit you for early withdrawal penalties long after your initial rate guarantee has expired.
So if you insist on playing this game, that’s OK. Just be aware that you’re significantly increasing your overall investment risk.
Most folks at or near retirement are looking for ways to reduce their risk not increase it. Here’s a better investment strategy. Take the mortgage payments that you no longer have to send off to the mortgage company (since I’ve convinced you to pay off your mortgage) and invest those in your favorite stock or mutual fund.
BE DEBT FREE
The single biggest hurdle that we all have to overcome to building and keeping wealth is eliminating debt.
Think about it, how much income do you need every month if you have no payments. No car payments, credit cards, not even a mortgage payment.
When you eliminate debt from your life, you reduce the amount of income you need from your investments. This gives you increased freedom to be more conservative with your remaining investments if you choose, since you won’t be needing to make as much money (i.e. income) thereby allowing you to accomplish your goals with lower investment returns.
Remember, lower investment returns aren’t necessarily bad provided you’re lowering your risk proportionately.
In working with over 736 retiree’s I can tell you from experience that people with no debt worry less about their money.
If you haven’t done so already, make one of your top goals to become totally debt free at or before retirement.
If you have debt, get rid of it before you do any other investing. If you have investments and debt, sell your investments and get rid of your debts. Then take the increased cash flow you’ll have and build back up your investment accounts.
Note: These comments only apply to non-retirement account investments. Pulling money out of retirement accounts to pay off debt can be done, but done the wrong way you could end up paying thousands of dollars in unnecessary taxes and penalties. Make sure you know the tax rules on retirement plans inside and out, otherwise be smart, get really good advice from an expert in this area.
