Military Financial Advice - Military Times

Paying off mortgage has long-term benefits

Deciding whether to pay off your mortgage is an important part of your financial planning process. Although mortgage rates are low and there’s a probability of getting equal or greater returns in the stock market, I have found that, in many cases, it makes sense to pay down or pay off your mortgage before you retire.

If you pay off your mortgage, you reduce the amount of retirement income devoted to monthly expenses. If most or all of your retirement income comes from your investments, paying off your mortgage will reduce the amount of capital needed to provide your monthly income.

For example, if the beginning principal on a 30-year mortgage is $175,900, with a fixed interest rate of 5.5 percent, the homeowner needs $998.74 per month to pay the principal and interest. If that mortgage is paid off at retirement, monthly expenses are reduced by nearly $12,000 per year.

If the income needed to pay the mortgage comes from investments with a 5 percent rate of return per year, $240,000 in capital will be needed to generate the income to pay this mortgage.

Where does the 5 percent rate of return come from? The stock market has returned more than 5 percent over a long period of time, but in the short term, returns can vary dramatically from year to year. To be sure that you will have a predictable amount of income to pay the mortgage, bonds or certificates of deposit are more appropriate. A reasonable rate of return to expect on this type of investment is 5 percent.

Here’s the calculation: If the annual income required for the mortgage payment is $12,000 and the rate of return on investments is 5 percent, divide $12,000 by 0.05 and you come up with $240,000.

Although a military pension provides a predictable and inflation-adjusted payment each month, many of us will not have a pension except for Social Security. So some or all of our monthly retirement expenses must be met by the income and appreciation on our investments.

You can calculate the amount required to reduce your mortgage to zero at www.mortgage-calc.com. Using the mortgage in the first example, the following monthly payments will reduce this mortgage to zero in the time specified:

• 30 years: $998.74

• 20 years: $1,209.99

• 15 years: $1,437.25

• 10 years: $1,908.98

If you can’t pay off your mortgage, you can reduce the balance as much as possible in your pre-retirement years and refinance just before you retire with a new 30-year mortgage.

Additional points:

1. If you plan to reduce your mortgage to zero in 15 years, but refinanced with a new 30-year mortgage, pay whatever additional monthly amount is needed to stick to your original 15-year repayment schedule.

2. Many people believe it makes sense to have the largest possible mortgage because the interest is tax-deductible. This may be true in your highest earning years, but it is usually not beneficial in retirement. Common sense will tell you that you’re better off without a $1,000-per-month mortgage payment, even if the maximum tax rates are 50 percent (for federal, state and local income tax).

If 80 percent of your monthly mortgage payment is deductible interest, at a tax rate of 50 percent, you will save only $400 in taxes with this deduction. Without a mortgage payment, you will reduce your monthly expenses by $1,000 per month.

3. If you file your taxes using the standard deduction and do not itemize on Schedule A, the mortgage interest deduction does not provide a tax benefit.

4. Biweekly mortgage plans allow you to make an extra principal payment each year, which will pay off your 30-year mortgage in about 23 years. If you are paid every two weeks, biweekly mortgage plans make it easier to pay the mortgage if the payment is divided into two smaller payments each month.

Having a home that is paid for provides many people with substantial psychological and economic benefits. If you are still working, you may be able to save additional amounts that would otherwise be used to pay the mortgage. And you will have an asset that can be sold to provide capital for retirement if you move to a less expensive home.

Tagline: Barbara H. Pietrowski is a licensed certified public accountant, certified financial planner and personal financial specialist. E-mail her at barbarapietrowski@yahoo.com.