I often get asked whether you should pay off your mortgage early. In these times of low interest rates it doesn’t seem like you gain much when you do. For a number of reasons, paying down your mortgage shouldn’t be your first priority, but if you are otherwise out of debt, and you are meeting your retirement and other savings goals, paying off your mortgage should be next on the list.

Mortgage debt is the lowest cost form of consumer debt. Today a thirty year fixed rate mortgage will cost you about 4.3 percent and the 15 year mortgage will cost you about 3.5 percent. If you happened to buy your home when rates were at their lowest, your interest rate could be as low as 3.3 percent. When you tack on the mortgage interest tax deduction the rate is even lower. The following table shows before and after tax mortgage interest rates.

With rates this low, paying off all other forms of debt is your top priority. And even though holding this debt on your home is costing you money, earnings on your retirement savings out weigh the benefits of paying off your mortgage early. But if you are on track for saving for retirement, and don’t have any other debt, paying down your mortgage is a good next step.

Mortgage vs Investing

Paying down debt is a form of saving, and it provides a guaranteed rate of return. Every dollar you pay, you reduce the amount of interest you pay. Even though mortgage rates are low, they still offer a relatively high rate of return for risk free investments. One year Treasury bonds yield less than 1.0 percent. CDs offer similar returns. Slightly riskier fixed income investments, like one year corporate bonds, only pay a little more than 1.0 percent. But on every dollar of mortgage interest you avoid you earn your mortgage interest rate.

Yes there are riskier investments that have higher expected returns. Historically, the average stock market return has been 10 percent. Wouldn’t that be a better place for your money than paying down your mortgage? For your retirement savings goals yes. Those are very long term goals. But if you are meeting those goals, it’s worth considering the relative risk of investing in the stock market versus paying down your mortgage.

If you choose to invest in the stock market with your next savings dollar, rather than pay down your mortgage, you are essentially borrowing money to make the investment, all be it at a very attractive interest rate. Your net return is the market return minus your mortgage interest rate. That would be an average return of less than 6 percent at today’s mortgage rates. Not much more than the guaranteed return of paying down your mortgage, but with a lot more risk. Your actual return in the stock market fluctuates widely from year to year. It only has to dip down to 4.0 percent to give you a negative return after your mortgage interest. That has happened in about four of every ten years.

Mortgage vs Security

While we can quibble about the attractiveness of a higher risky return versus a lower, but attractive, risk free return, one thing is certain. Eliminating all forms of debt makes you more financially secure. That is particularly important when you aren’t getting a paycheck. If your scheduled mortgage payments would have you continuing to make payments beyond your retirement date, it is important that you find a way to eliminate your mortgage before you stop working.

According the Consumer Financial Protection Bureau, in 2011, those over the age of 65 who owned their home and still had a mortgage were paying nearly three times what those without a mortgage were paying for housing. With no mortgage payments, your draw on your savings will be smaller, making them last longer. If your savings have suffered from an investment market downturn, you will be better able to weather it, because your overall expenses will be lower.

Compare two women, Valerie and Jocelyn. Both are single and recently retired. Valerie has a pension from her government job, while Jocelyn has retirement savings. Both women will have about the same amount to live on, around $4,000 per month.

Valerie, due to a recent divorce, will have to take on a mortgage of around $100,000. Her payments will be at least $500 per month excluding taxes and insurance.  With the new mortgage payment, Valerie’s expenses will consume all of her income. As other expenses increase with inflation, Valerie may find herself pinched and need to find ways to cut back on her lifestyle. Jocelyn’s home is paid off, and as a result she has much more financial flexibility. Her cost of living is low and has plenty of room to grow if inflation forces it up. Jocelyn is much more financially secure than Valerie.

We are lucky to live in an era of low mortgage interest rates. It makes the cost of housing more affordable. So paying off your mortgage, unlike other forms of debt, doesn’t need to be a priority. But when you run out of other savings goals to fulfill, paying off your mortgage is well worth it. It’s hard to find a better guaranteed rate of return and getting rid of your mortgage payment before you stop working for pay will make you more financially secure.

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