Should You Pay Off Your Mortgage?

I know what you are thinking. You’ve lost so much in the stock market. If you’d only taken that money and paid off your mortgage! Is it too late? Should you bite the bullet? Sell off what you have left in your mutual funds and pay off the home loan?

Of course the answer is very simple. It depends.

From an emotional stand point, it might feel very good to pay off that mortgage. And while I think that the emotional component is very important, it certainly should not be the only consideration.

Generally speaking, the best way to make this decision is to look at the rate you currently pay on your mortgage (or the rate you could refinance at), how long you’ll keep the home, and the OBJECTIVELY DETERMINED expected rate of return of the alte
ative investment - in this case, the stock market.

For example. Lets say you have a 6% home loan. You can refinance at 5%, you plan to stay in the home for another 10 years and you expect the stock market to drop faster than a meteor. In this case, the first thing you do is STOP.

Sorry. It doesn’t matter what YOU expect the stock market to do. It matters what the OBJECTIVELY DETERMINED rate is over the next 10 years. I understand that this is impossible to know. But as painful as the market has been lately (and that’s an understatement) its still reasonable to expect that the market will retu
8% - on average - over the next 10 years. Of course the past is no guarantee of the future. But this is a very reasonable expectation. I know you feel like the market will never make a positive return for the rest of your natural life but this is just the inverse of how many people felt in the late 1990’s. They thought the market could never go down and they were wrong. Anyone who expects the market not to recover has no evidence to support that claim. Its just a feeling.

Back to our example.

Let’s not consider tax consequences for this illustration as it could get very sticky. (Obviously you should consult your tax adviser before making any decision such as this). In this case, the smart financial move is to keep your investments in tact- keep the mortgage and the mutual funds. By doing this you have the added benefit of keeping your assets diversified. And by the way, lets face it, real estate hasn’t been such a great place to have money lately either. Paying off the mortgage could be a disaster if real estate continues to wither.

OK. Simple decision….right? Wrong. It doesn’t end there.

Lets say you can’t sleep at night because you are so petrified about the market. In that case, there is a stronger case for paying off the mortgage. But this situation worries me. If you blindly give in to your fear today, what’s going to happen tomorrow? When the market takes off like a rocket (and it will at some point) are you going to refi, pull equity out out of your home and put it back into the market? My experience is that once you open the door to allowing your emotions to take over, its hard to put the intellect back in the driver’s seat.

Again, I do not believe the financial questions can be made without considering the emotions but I think we have to be careful and tread lightly.

Fear is something many of us are powerless over. The sooner we accept that, the better. It is a driving force in many parts of our lives. Fear can be a very good thing. It can keep us alive. But it can also kill off the most “alive” aspects of who we really are and it can muffle the only thing that sets us apart from the ants - our intellect.