I’m a huge fan of paying down debt. Nothing feels as free as knowing that you don’t owe a penny to anyone!
Given the current investment environment and the 2018 tax law changes, paying off your mortgage (or substantially paying it down) can make a lot of investment sense as well.
Assume you are worried about future market returns and are holding a large amount of cash in your investment account. What’s the best rate of return you can earn on that right now? Maybe 2.0%? Instead, consider using that cash to pay down your mortgage and earn an essentially risk-free after-tax return equivalent to your mortgage rate. I’m guessing that is probably somewhere between 3.5% to 5.0% or even higher.
But you may be thinking, “what about my interest deduction? I’m not really paying the 4.5% interest rate”. Under the new tax laws set to take effect this year, there is a much higher chance that you will be paying the full rate and taking a standard deduction rather than itemizing.
State and property taxes are capped this year as an itemized deduction at $10,000. So assuming no other itemized deductions, you need AT LEAST $14,000 of interest payments to qualify for itemized deductions. If you live in a low or no tax state, the interest payment required to itemize deductions becomes much higher.
In the above example, assume you have $25,000 in mortgage interest for the year and$10,000 in state tax deductions for a total of $35,000 itemized deductions. Considering you would have qualified fora $24,000 Standard Deduction anyway, you are really only receiving the tax benefits on $11,000 of your $25,000 of mortgage interest. Translation: Just under half of your interest is still paid on an after-tax basis!
When economic times are good, it may be OK to expand your personal balance sheet. However, towards the end of this type of cycle,you may be better off strengthening your financial position before the financial markets end up reducing the value of your assets in the next downturn.