Should I Pay Off My Mortgage? Part 2

Not a simple decision

Let’s return to Jim and Sue, our profoundly fortunate and financially savvy couple with the $200,000 windfall. Should they get rid of their monthly mortgage payment once and for all? They’ve never liked being in debt and feel that the moral high ground leads to a debt-free existence. “Neither a borrower nor a lender be” is their credo, and now is their big chance to truly live it. Besides, think of the interest they’ll save!

Their faces fall when I suggest they keep the mortgage. My actual advice is to refinance and take advantage of the historically low current rates. I note that this week’s market rates show a 30-year fixed rate mortgage at 5.3% and a 15-year fixed rate mortgage at 4.7% They tell me there’s no way they’ll ever agree to still having a mortgage in their 70s, let alone their 80s, so let’s just look at the 15-year rate at 4.7%.

Jim and Sue are currently in the 25% federal tax bracket. Because they always itemize and can take the income tax deduction for mortgage interest, the true cost of the mortgage is less than the actual amount, initially: in the first year, it’s 3.525%. Unfortunately, this income tax savings will decrease a little every year—all other things being equal—because the fraction of their monthly payment considered as interest decreases rapidly in a 15-year mortgage.

Jim and Sue might also protest that this refinance will likely cost them $3,000 in closing costs. That is true; there will be some break-even point to justify the bother and expense of refinancing. But they intend on staying in their house for at least 10 years, and more likely 20 years, and they are moving to a lower-interest loan over a shorter time. Without even getting out my calculator, I can safely say that this is a good bet.

Next week, we’ll cover more reasons to carry a mortgage.

By Deborah Hoskins, JD, CFP
The Wise and the Wary Blog