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Buying or Selling a Home
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Pay Off Mortgage?

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By babyfrog
June 3, 2003

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We've received an inheritance that would enable us to pay off our home mortgage. I know the traditional arguments against doing that, but our situation is different.

Charsoph,

Let me ask you the same thing I ask people all the time.
"What will allow you to sleep better at night?" If you pay off your mortgage, will you sleep better? Or will you stay up at night thinking "Since I'm not sure how much longer my medical condition will allow me to work, I should have taken the path that would have allowed me to potentially maximize my total net worth over time, because that way, I will have a bigger overall nest egg for the time when I can no longer work."

If you invest the money, will you sleep better at night, knowing that you have picked the path that, over the long term, could likely lead to a higher net worth? Or will you stay up at night worrying "What if tomorrow is the day that the stock market crashes again?"

In your shoes, presuming excellent credit, I'd probably refinance the mortgage (I can now get a mortgage at 5.2% from the S&L that is servicing my mortgage, nearly a full percentage point below what you listed (6.125%)), and take advantage of the lower rates to invest what's left of the inheritance money, at that much lower of a hurdle rate. Remember that first mortgage debt is generally tax deductible, so if your combined marginal income tax rate is 30% (Fed, state, local), that 5.2% loan is really closer to 3.64%, after taxes. (If your mortgage is THAT close to being paid off that it wouldn't pay to refinance at nearly a point cheaper, or if your credit is such that you can't get a better rate, then never mind!)

Many tax-free (depending on what part of the country you live in, and whether or not the Alternative Minimum Tax affects you) municipal bonds have higher yields than the after-tax cost of a 5.2% mortgage. This would mean that even taking that relatively low amount of risk, you could end up better off keeping the mortgage and investing.

But I'm not you. I'm not in your shoes, and I'm not the one that has to sleep at night, based on whatever decision you make. There is value in being completely debt free. Until I bought my house, I was living completely debt free, and my core living expenses were a lot easier to reach every month, as a result. It was a very nice feeling to have. There's a lot to be said for psychological (as opposed to financial) well being, and if your ability to enjoy your life will improve by paying off your mortgage quickly, then by all means, DO IT. The reduced headaches from fewer bills, lower expenses, and a lower risk investment strategy may more than compensate you psychologically for the potential lower financial returns than you may have earned if you had invested the inheritance instead.

Unfortunately, there's no easy formula to plug in - you need to make the decision yourself, based on your goals, your desires, and your ability to sleep at night.

Best of luck!
-Chuck


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