Posted on 07/15/2009 6:48:43 AM PDT by Kaslin
Dear Carrie: I have over $600,000 in CDs at 3 percent interest. I have a mortgage balance of $100,000 at 5.125 percent. Would you advise that I go ahead and pay off my mortgage or leave the money in CDs? -- A Reader
Dear Reader: On the surface, the answer to your question might appear to be a simple calculation. But in reality, the decision to pay off a mortgage can be more complex. So I'm going to start by posing a few more questions that you may want to factor into your decision.
For instance, how many years are left on your mortgage? How close are you to retirement? Does the $600,000 in CDs represent your complete nest egg? Since I don't know your specific answers, I can only give you some broad guidelines to take into consideration.
Consider the real cost of your mortgage.
You say your current mortgage is at 5.125 percent, but have you factored in the tax deductibility? Let's assume you're in the 35 percent tax bracket and your mortgage interest is fully deductible. In this instance, a 5.1 percent mortgage would actually cost around 3.3 percent. Almost a wash with the 3 percent you're making on your CDs.
Factor in future investing opportunity vs. risk.
As I'm sure you know, investments that carry the most potential for reward generally also have the highest risk. A CD is at the very low end of the risk/reward spectrum. So think about your comfort level. Would you prefer to invest your money in potentially higher-yielding investments? If you think you can do better than 3 percent and are willing to take the risk, perhaps paying off your mortgage isn't the right decision.
On the other hand, current interest rates on CDs are very low right now. If you don't want to increase your risk level and can't match the 3 percent you're making now as your CDs come due, taking the money and paying off your mortgage might make the most sense.
Determine your cash needs.
It appears you're in a very strong cash position, so liquidity may not be as much of a concern for you as it might be for others. A preference for liquidity might keep you from paying off a low-rate mortgage prematurely even if you can't do as well or better with an alternative use of the money. Diversification could play a role here, too, as you look at your mortgage in light of your overall financial plan.
Evaluate your tax situation.
Home mortgage debt remains one of the few sources of tax-deductible interest expense left to individuals who aren't involved in a trade or business. IRS rules say you can deduct the interest expense on up to $1 million ($500,000 for married filing separately) of home-secured debt used to purchase or make capital improvements on your qualified principal and/or second residence.
You can also deduct the interest expense on up to $100,000 ($50,000 for married filing separately) of home equity debt secured by your home, whether in the form of a regular loan or revolving line of credit. Once you've paid off the original mortgage, you'll be limited to the $100,000 home equity debt ceiling unless you make capital improvements or buy another home.
Because your current mortgage balance is $100,000, this may not be important to you. Also, if you have fewer than 10 years left on your mortgage, more of your payment is likely going toward principle than interest, so tax deductibility may not be a real concern.
Think about your peace of mind.
For some folks, a strong desire to be debt-free overrides other considerations. There's an emotional security in owning your home free and clear, and this seems to be especially true for those who are near or in retirement. If that's the case for you, all other concerns may take a back seat.
As you can see, there isn't one right answer to your question. It's more a matter of the right balance for you. If the time you have left on your mortgage is short, if the tax deduction is not significant, and if you're secure in the amount you have saved for retirement and less concerned about future investing opportunities, you may very well benefit from paying off your mortgage. As always, you should check in with a financial advisor for a more in-depth review of your personal situation. Ultimately, it sounds like you're in a good position no matter what choice you make.
Good luck!
Why not?
Pay it off and sell,sell,sell and take the money and run before you lose your shirt on your property.Get cash rich and invest.
Speaking from personal experience, when you have the money to pay off the house, do it.
“All bets are off if the government decides that interest deductions for homes are benefits of the “rich” and puts a stop to the practice.”
I think there’s a strong chance that will happen. The Dems tried to make everyone a homeowner, but found that poor people tend to have bad habits, such as not working, or paying their bills, which would include a mortgage.
In frustration over the inability to give a house to everyone, I expect the Dems to punish homeowners by removing the interest deduction for just the reason you state... it’s a benefit to the “rich”.
Complete and total claptrap! Paying off your mortgage means you’re relieved of a $900+ burden every month, EASILY overcoming the tax benefits realized from maintaining the mortgage.
How these financial planners promoting mortgage retention stay in business is beyond me. That’s the first, and often the last, question I ask when I meet with a financial planner. If they advocate for holding the mortgage, I get up without a word and walk out.
A half-million to begin with; but she could then funnel her mortgage payments into her investment portfolio and build it up quickly.
More simply, if you had a paid for house would you borrow against it to purchase CDs? My guess is no. This question takes the emotional aspect into account, something that most finance geeks forget.
I’m also amazed when the “tax deductibility” issue arises and supposedly smart people say to keep the mortgage to get the deduction. How much more ignorant can a person be? Why on earth would someone want to pay $10K to a bank to avoid paying $3K to the government?
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Yes, wrong answer. Under only the right conditions does the tax on your CD interest get canceled by the tax break on the mortgage interest you pay.
I got screwed in 2007 from this. Other capital gains pushed me into a bracket where my mortgage interest deductability got seriously reduced. So I pay taxes on the CD interest and did not recoup it on the mortgage side.
“One other point to consider...”
That is the tack my wife and I are taking. If inflation kicks in, and I believe it will, it makes sense to pay off the note with cheaper dollars. Our plan is to use the best vehicle to get the highest rate of return on our portfolios. It isn’t foolproof - but nothing is. My only caveat would be if you don’t have a fixed rate mortgage - I would pay it off as soon as possible. -—JM
If inflation rears its ugly head(which is almost a near certainty), the interest rate on her mortage could be less than the rate of inflation and she would be able to invest her expiring cds at at rate exceeding her mortage rate.
Great point and that is what we did over 20 years ago
Well, if it were dollar for dollar, I'd rather pay it to the bank than the goobermint, because at least the guys at the bank have a job, of sorts. Starve the beast. But $3 to save $1? No thank you. My father in law spouts this crap.
Gee a reasonable person using common sense - too bad the guys in congress don’t have the same stereet smarts you have used to explain debt, cash flow and investing.
I really like Dave Ramsey on liability management (i.e. get out of debt, and don’t overspend on cars). I also have found his life insurance advice very helpful, (term insurance + savings is better than “whole life” in most cases)
One area where I don’t agree with him is in investing of assets. He’s so convinced that at all times the stock market is the way to go that he has gone right ahead encouraging people to put their money in “growth stock mutual funds” right through two stock market bubbles. I wish he would recognize that just as with houses and cars, the price you pay for a stock market investment has a huge impact on whether it works out or not. There ARE times when it makes sense to put money in the market (now is probably one of those times) but there are also times when the PE is above 30 or something, when it’s crazy.
Pay off the mortgage. Debt is bad, unless you are from the government in which case the solution to debt is more debt.
If someone really, really, really wants to starve the fed government and they have a paid for house, they are still free to give to charity. In addition, if the person really finds that they hate having a paid for house, then they can always go get another mortgage for it....
Very good advice.You think like I.
“Paying off your mortgage means you’re relieved of a $900+ burden every month.”
It also means you are “relieved” of the possibility of earning a higher rate of return on the money you used to pay off the mortgage.
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