Emotion vs. Reason:
This is a question that we discuss frequently with our clients because there is often a perception that by having your home paid off, you are removing a source of stress or uncertainty. On an emotional level, this appeals to many folks. But it is the wisest financial decision?
In most cases, we think the answer to that question is “No”, it is not the best use of your funds. Why?
Liquidity Needs:
You are tying up your liquid assets into the walls of your home. For some, liquidity is not an issue as they have plenty of other cash assets available. For many, however, who are still in the process of wealth accumulation, tying up their liquidity limits their options for investment and for possible emergencies.
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- IF there was a true emergency of some sort, do you have enough accessible cash or assets that can be easily liquidated to cover your immediate needs?
- If you are invested in stocks, bonds, ETFs, etc., these can be easily and quickly converted to cash.
- Can you do the same with a house? While homes are selling relatively quickly these days, it is usually not an immediate infusion of cash, and closing times can be between 30 and 60 days.
- IF there was a true emergency of some sort, do you have enough accessible cash or assets that can be easily liquidated to cover your immediate needs?
Historically Low Interest Rates:
Not taking advantage of generationally low interest rates. When individuals can finance or refinance their homes for between 2 and 3% fixed-rate mortgages for 15 to 30 years, this is a historic opportunity to utilize the cheapest debt that most of us will ever see.
- Can you think of a cheaper way to finance renovations or updates, and deduct the interest?
- Again, compared to the return on your investment portfolios: are you averaging 6 to 10% per year in returns? You are far exceeding the interest on your mortgage, so your money is kept working, making money, at the same time your home is still appreciating in value, at least currently.
Impact of Inflation:
Overlooking the impact of inflation: We talked a bit about inflation last month (Because You Asked: Should We Be Concerned About Inflation?), but here is another effect of inflation that many do not realize: as inflation rises, existing debt becomes ever cheaper.
- If your home mortgage is at a fixed 2.5%, and inflation is steady or rising at 4 – 6%, cash now is worth more than cash in the future. So, debtors are paying back lenders with money that is worth less in the future than when they actually borrowed it!
These are some of the logical and financial reasons that we consider when advising our clients about whether or not they should pay off their homes. We emphasize the logical and financial description of this rationale because when it all comes down to it, the decisions that we make about our homes are often based on the emotional vs. rational drivers of the decision. And if you are sufficiently blessed to have the option to go ahead and pay off your home, sometimes the peace of mind that this brings far exceeds all of the other reasons we can give you to not pay off your home.
