I currently pay $300,000 on my home at 2.5%, with a 30-year mortgage. I have my retirement accounts – IRA and 401(k) – and am looking to retire in less than 10 years. I will receive an inheritance of at least $300,000, so I can pay off the house.
I am in a very fortunate position. Should I pay – or should I invest the money?
Homeowner
Dear Homeowner,
By paying off your loan early, you’ll save a significant amount of interest, typically at 2.5 percent. Millions of homeowners would kill for that amount.
Of course, many of them are related to luck. Let’s take a moment: 30-year mortgage rates are currently over 5.5%. The consumer price index rose 8.5% in July from a year ago, and the closely watched “core” inflation – excluding volatile food and energy – was hovering at 5.9%. With an interest rate of 2.5%, you’re making money simply by living your life.
As my colleague Aarti Swaminathan says: “As the cost of their car, gas, electricity and other expenses increases, so does that homeowner’s home value with inflation.” However, their mortgage payments are the same because they are not adjusted for inflation, meaning they are still paying the same amount as they were before inflation.
Overpayment some If you can, pay higher interest payments, especially early in the life of the loan. Depending on the terms of your mortgage, you may be limited to the amount of overpayment you can make (10% in some cases), and while it may seem worthwhile, there may be a penalty for overpaying. In your case, that might actually be a good thing.
“With an interest rate of 2.5% and inflation at 8.5%, you are already making money living your life. “
Assuming you have a healthy 401(k) and IRA, 6 percent of your retirement savings will do a lot of hard work to offset your 2.5% interest. Talk to a financial advisor, and make sure you’ll still have enough to live comfortably and pay off and/or reduce your mortgage.
Larry Pohn, a financial planner in Redwood City, Calif., says of financial advisors, “People with more money face your dilemma, and there’s no right or wrong answer.” He agrees with me: “I do both.” I will not pay the loan and contribute heavily to the inheritance, but make a combination.
“Since you’re 10 years from retirement, I’d suggest investing in an inheritance with a moderate allocation, between 50/50 and 60/40 to stocks and bonds. This portfolio can generate enough income to increase your mortgage payment,” Pohn said. You may not notice any difference in your flow and pay off the loan in 10 years.”
Continue to raise those accounts. “I assume you’re over 50, so you can put $7,000 into an IRA and $26,000 into your 401(k). I’ve been doing this for 36 years and I’ve yet to meet someone who has saved so much for retirement,” Pohn added. “I encourage you to continue to maximize your retirement plans to make your retirement more secure.”
Pon outlines the advantages/disadvantages of investing and paying off loans. Here are its advantages: 1. No more mortgage payments. 2. Paying off debt is a risk-free investment. “You’ll save at least $1,200 a month, which means you can divert your payment toward your savings instead of paying the mortgage.” 3. “This will make your retirement more secure.”
And the cons: 1. Your mortgage rate probably won’t be lower anymore. 2. If you invest $300,000 instead of paying off the loan, you take on investment risk. 3. “Even in the current market, your return on investment is expected to be above 2.5%. This is not risk free or guaranteed, but taking some risk will give you a big return.”
What if it was me? I will pay off the loan. I don’t like debt. We spend the first part of our lives desperate to get a loan, then the rest we worry about paying off. They are important, if sometimes unhealthy, obsessions. Mortgages give us something to focus on besides the other “M” word: our mortality.
However, life would be sweeter if the mortgage was paid off. Until the next obsession comes along.
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