Making Cents: Should you pay down your mortgage?
By: John P. Napolitano, CFP®, CPA, PFS, MST
The second half of the American dream of home ownership is to own that home without a partner, AKA a mortgage. For some, this may be a brilliant strategy. But for others, in the long run it may be that not paying it down faster is a better choice.
Most people want a mortgage to get a tax break. But that changed materially in the last tax act to where you may not be getting much of a break on your mortgage anymore. For large mortgages taken before 2018, you may deduct interest on mortgages up to $1 million. Since 2018, that cap has dropped to $750,000. But just because you have a loan doesn’t mean that you are getting a tax deduction for it. There are other factors such as the new, higher standard deduction. If your standard deduction is higher than all of your itemized deductions including mortgage interest, then you’ll actually have no tax benefit from the loan. In that case, the advice may lean towards retiring that debt faster than scheduled.
Beyond taxes, there may be some core financial reasons why you would or would not pay that mortgage down quicker than the amortization schedule. The first may be other, higher rate debt that you have. Two examples could be school loans or credit card debt. In general, it may be wise to accelerate payments of your highest costing debt first.
Another reason may be higher priorities. If you don’t have a retirement plan or a college savings plan going yet, it may be better to begin investing in these rather than simply retiring your home mortgage. College savings makes sense if you intend to pay for a child’s higher education. If you wait until college starts, and must go the loan route, you’re likely to incur debt at a higher rate than your home mortgage.
Adding to your retirement accounts may also be a better alternative. In general, you’d have to assess your probability of earning more in your retirement account than you would by paying down the debt. For example, if your mortgage rate is 4.5%, how likely are you to earn more than that in a retirement account? The answer is who knows for sure, but long terms investors typically have a target rate of return in mind and understand that in some years you will earn less and in others you may earn more.
Other, higher risk loans that you may consider retiring before your mortgage would include a loan against any 401K plan or a loan with a variable rate that could spiral out of control should rates ever get prohibitively higher again. The 401K loan is significant in that if you ever change jobs or your company gets sold, that outstanding loan could become taxable to you with an early withdrawal penalty if not handled properly. While any variable rate loans you have today may still be low cost, that can change and financially conservative people could consider eliminating that possible exposure.
John P. Napolitano CFP®, CPA is CEO of U. S. Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. US Wealth Management, US Financial Advisors and LPL Financial do not offer tax advice. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.