Accretive On: Should I Pay Off My Mortgage?

May 22, 2019

Markets are hitting all-time highs and you’ve been saving extra cash each month. You look at your budget and personal balance sheet, and one item stands out in both – your mortgage. Many people are asking themselves; is now a good time to pay it off?  

For some, this question is a closet market timing question. They believe markets have reached a top and want a reason to sell. For others, it’s a peace of mind question; people are trained to think less debt is good and the goal is to be mortgage free. We’ll address both of those lines of thinking.

The interest rate on your mortgage is simply a hurdle rate for your cash and investments. If you can earn more on your cash and investments than your after-tax mortgage rate then mathematically you’re better off carrying the mortgage. This raises two questions – what do I mean by after-tax mortgage rate, and how do you know whether cash and investments will beat that hurdle?

If you don’t itemize your deductions then the after-tax mortgage rate is the stated rate. However, if you itemize your deductions then you are still getting a tax deduction on the interest paid on qualified residence loans of up to $1,000,000 if you took out the loan before 2018 and $750,000 if you took it out after the 2018 Tax Cut and Jobs Act. For example, if you have a mortgage of $500,000 at a rate of 4% and you’re in the 22% Federal tax bracket then your after-tax mortgage rate is 3.12% because you’re getting a deduction on the interest paid.

Now you know the hurdle rate for your cash and investments. Can you exceed it? Your mortgage is a going to be a long term (15 – 30 year) liability. First, it’s beneficial to have a historical perspective on what 10-year returns were on a globally diversified 60% equity/40% fixed income portfolio. For our example, we use the MSCI All Country World Index TR for equities and Bloomberg US Aggregate Total Return Index for bonds, rebalancing quarterly. During the 10-years ending April 30, 2019, this type of portfolio generated an annualized return of approximately 8.13%.  (Source: YCharts)

Historical returns would exceed today’s mortgage hurdle rates regardless of whether one itemizes or not. There are reasons to believe that prospective returns over the next ten years may be lower than the last 10 years, but subsequent returns would need to decline significantly for an investor with moderate risk tolerance to not exceed the mortgage hurdle rate.  

While there is certainty that comes from paying off a mortgage, you need to keep perspective that the cost of borrowing for a mortgage for the next 15-30 years continues to be very inexpensive, especially relative to the alternative uses for the cash. This continues to be true even as the market continues to hit new highs. If you’re retiring or already in retirement and the monthly payment is painful for you then consider talking to your advisor about setting up recurring monthly distributions from your portfolio instead of taking out a lump sum at once to pay off the balance of the mortgage. Cash flow planning is a crucial part of any retirement plan and is an analysis Accretive offers to our clients.  

If you have questions about your situation then we’d welcome a conversation with you on how we can help.  

Financial Planning

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Accretive Wealth Partners, LLC (“Accretive Wealth”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Accretive Wealth and its representatives are properly licensed or exempt from licensure.This commentary is a general communication and the information contained herein is being provided for educational and informational purposes only. This commentary does not constitute investment advice and it should not be relied on as such. It is not intended to be and should not be considered a solicitation to buy or an offer to sell a security or a recommendation for any specific investment product, strategy, security or any other purpose. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. Any examples used are generic, hypothetical and for illustration purposes only. Prior to making any investment or financial decisions, an investor should seek individualized advice from a personal financial, legal, tax and other professional advisors that take into account all of the particular facts and circumstances of an investor’s own situation.Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions that are solely the opinion of Accretive Wealth and should not be construed as indicative of actual events that will occur.Any performance presented herein is for illustrative purposes only. Past performance shown is not indicative of future results, which could differ substantially.  Current data may differ from data quoted.The views and strategies described herein may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities or gain exposure to such asset classes and financial markets.Information contained herein that is not proprietary to Accretive Wealth has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Accretive Wealth.For additional information, please visit our website at www.accretivewealthpartners.com.