5 Questions to Help You Decide: Pay Off the Mortgage Now or Not?

There's something to be said about owning your home outright. In addition to being free of monthly mortgage payments, you have the security of knowing that, regardless of what happens, you'll always have a roof over your head.

That being said, there's a trade-off associated with paying your mortgage down in one fell swoop. And in many cases, it simply isn't the prudent thing to do even if you have the means at your disposal. What follows, in turn, are five questions to help you to decide whether the trade-off is worth it.

1. Do you have ample liquidity?
Two things happen when you pay off your mortgage. First, you eliminate a liability -- in other words, a debt -- from your balance sheet. And second, you transform one asset into another -- in this case, probably cash or stocks into a house.

The virtues of the first are self-evident, as you no longer have a debt hanging over your head akin to the Sword of Damocles. In addition, it frees you from paying interest and thereby enriching the increasingly unpopular increasingly unpopular mortgage giants, including Wells Fargo and Bank of America (NYSE: BAC  ) , the first and third largest mortgage originators in the country. Bank of America, in fact, now has the worst reputation in the entire banking industry.

The second one, however, isn't quite so clear cut. Sure, owning your home outright is great, but you can't cut off a part of the kitchen counter to pay for groceries. Nor does the electric company accept a chunk of drywall in lieu of cash.

The point is that you should only convert liquid assets into an illiquid asset if you have an abundance of the former (and will continue to even after doing so). If you think it's a drag to pay a mortgage every month, just imagine not having the means to put food on the table or gas in the tank.

2. What's the opportunity cost of your money?
Along these same lines, even if you have an abundance of liquid assets lying around, that still doesn't mean you should necessarily convert them into a house. You first have to consider what you'd be giving up versus what you're getting in return -- something economists refer to as "opportunity cost."

While a house may be an asset, that doesn't mean it's also an investment. The reality is that home prices don't appreciate over the long run, at least not in excess of inflation. According to Robert Shiller, probably the foremost (and legitimate) expert on home prices, "From 1890 to 1990, real inflation-corrected home prices were virtually unchanged." And unlike dividend-paying stocks or interest-bearing bonds, they don't produce income.

As a result, you should think long and hard before giving up the opportunity of actual investments in exchange for what amounts to a home's deadweight on your personal balance sheet.

3. Should you refinance instead?
There's been a lot of discussion in the media recently over mortgage rates. And rightly so. Since the end of May, the average rate on a 30-year fixed-rate mortgage has skyrocketed, going from below 3.5% to above 4.5% -- though they recently settled back down to around 4.37%.

But what's often lost in the hysteria, is that mortgage rates are still dirt cheap. The average rate on 30-year fixed-rate mortgage since 1971 is 8.61%, or nearly twice the current rate. As a result, maybe the right question isn't whether you should pay off your mortgage, but rather whether you should refinance it.

As my colleague Dan Caplinger recently discussed, the key to any refinancing decision is how much money you can save by doing so. "Typically, one rule many people follow is that if you can cut your interest rate by a full percentage point without having to pay points or other big costs to get a new mortgage, then refinancing makes sense."

4. Do you benefit from the mortgage-interest deduction?
If nothing else, the past few years have taught a lot of Americans that owning a home simply isn't all that it was purportedly cracked up to be. I could go through a laundry list of statistics about foreclosures and underwater homeowners to demonstrate the point, but I suspect that doing so isn't necessary.

That being said, for those with the means to do so, there is one clear advantage: the mortgage-interest deduction. A relic from pre-1986 tax law, when all interest on personal loans was deductible, this provision allows taxpayers to write off the mortgage interest they pay each year on up to $1 million in mortgage debt. For those of you in a high tax bracket, and depending on how much of your monthly payments are attributable to interest, giving this up could amount to a sizable monetary sacrifice.

My recommendation? Check how much you saved in taxes last year to determine whether giving this opportunity up is worth it or not.

5. Will you sleep better at night?
At the end of the day, what ultimately matters is your happiness. If paying off your mortgage will make you feel better about life and give you peace of mind, then, by all means, that's what you should do. To be sure, the companies on the other side of the transaction, such as Ocwen Financial and Nationstar Mortgage Holdings, aren't looking out for your best interests and, in fact, would probably prefer that you not make your payments on time, as that increases their fees.

I'll be the first to admit that this decision amounts to more than just money or a simple mathematical calculation. It is, in a sense, the ultimate realization of the American dream.

At the same time, however, as we've learned over the past few years, ignoring the math can turn that dream into a nightmare. Thus, to channel Comcast's recent string of popular television commercials: Don't turn your dream into a nightmare. Do the math.

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  • Report this Comment On July 20, 2013, at 10:28 AM, NEFlyfisher wrote:

    I am a retired mortgage broker and financial adviser. I fielded many questions about the tax consequences of paying off a mortgage early. My first response was that it probably didn't make sense to send a dollar in interest payment to the bank to save 30 to 50 cents on income tax. My second response was to check with a tax expert to see the total financial implication in the context of their financial and tax situation. It isn't always clear cut.

  • Report this Comment On July 20, 2013, at 10:54 AM, sabebrush6 wrote:

    Answer to #1: Do you have ample liquidity?

    If you keep your savings like I did and pay off your mortgage out of your paycheck, this is not an issue. I worked quite a bit of O/T and had plenty of extra weekly cash. Boom - paid off the house. Don't rape your savings. This would put you in the same class of stupid as the government is when it rapes SS to pay something else.

    And yes, this is a a REALLY FEEL GOOD issue.

  • Report this Comment On July 20, 2013, at 12:29 PM, antaddie wrote:

    What happens to the rest of the mortgage after paying half of the prncipal.

    Do they recalculate the monthly payment?

    Should we refinance?

  • Report this Comment On July 20, 2013, at 3:22 PM, dbtheonly wrote:

    antaddie,

    Should you refinance? Read the article. Can you cut your rate 1% without a bunch of costs?

    What happens at the 50% mark? Not much? You owe that much less & the interest/principal spread gets better.

    Your payment should be recalculated yearly based on the taxes & insurance but your rate won't change absent a refi.

    NEFlyfisher,

    I can take my $10 & pay down my 3.375% mortgage or I can put that $10 into NGG & make 7%. I don't see that as a hard choice.

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