Should You Pay Off Your Mortgage?

Paying off my mortgage was one of the most freeing financial moves I ever made. But plenty of naysayers told me it was stupid.

Should you pay off your mortgage? That depends.

Financial experts talk about "good debt" vs. "bad debt." Credit card bills, department store accounts, and car notes could be classified as "bad debt," i.e., financing a depreciating asset or continuing to pay for an experience or product that has already been consumed. "Good debt" normally produces a return on investment. For example, a mortgage on a home that not only provides you with a place to live but also is likely to appreciate in value. Some people consider a student loan "good debt" because you're financing an education that may enable you to land a higher-paying job.

By all means, don't pay off your "good debt" until you've paid off all your "bad debt."

Another reason to classify an obligation as "good debt" might be that the interest is tax deductible. Especially in the early years of a mortgage, homeowners can enjoy a healthy reduction in taxable income. Under the new tax law, with the standard deduction increasing so much that fewer taxpayers will benefit from itemizing, carrying a home mortgage might not be as attractive.

Mortgage interest rates tend to be lower than personal interest because the loan is secured by an asset. Credit card interest rates are high because there's very little the company can repossess if you default. (Another reason to get rid of that "bad debt" first.)

Interest rates have been low for many years, which reduces the incentive to pay off a home loan. Common advice is to buy as much house as you can afford, taking on the biggest mortgage you can qualify for. With borrowing so cheap, why not add a home equity loan to make all those needed improvements and further increase the value of your asset? Our federal government seems to subscribe to that philosophy, as the national debt continues to soar while the interest paid on Treasury bills is almost negligible.

If you have disposable income to put toward retiring your mortgage and you're otherwise debt-free, first look at other uses for that cash. For example, have you built an emergency fund with at least three to six months' living expenses? Are you contributing as much as you can to a retirement account? If not, fortify those areas first.

Assuming you have a healthy emergency fund and are already maxing out your retirement savings, should you then start paying off your mortgage? Or look for after-tax investments? That depends.

What is your tolerance for risk? What rate of return do you expect to get from your investment? When my husband and I paid off our mortgage, our interest rate was almost seven percent. We would have had to take a lot of risk to find an investment returning seven percent at that time. Paying off our own mortgage was a safe, guaranteed investment, and it took a huge chunk out of our monthly living expenses.

Lowering your monthly living expenses by getting rid of the mortgage payment might be especially important if you're planning to retire soon, or if you anticipate lower income in the near future. In our case, we both worked for the same company, which was teetering on the edge of bankruptcy, and we were concerned that one or both of us could lose our jobs.

If you have a very low interest rate on your home loan and your income status is secure, you might be able to find an investment that produces higher returns. But as mortgage interest rates climb, prepaying the loan might come back in vogue. In a future post, I'll discuss how to do it.

Have you ever considered paying off your mortgage? I'd love to hear your comments.

Sharon Marchisello is the author of Live Cheaply, Be Happy, Grow Wealthy.