Homeowners love to compare notes on their mortgages — and brag about locking in low rates and avoiding fees.
In this era of low interest rates, mortgages seem hotter than ever. Who wouldn’t want to pay less than 4% for a fixed loan to afford a bigger house — while reaping the mortgage interest deduction?
Allan Roth, for one.
A certified financial planner in Colorado Springs, Colo., Roth, 59, rejects the notion that mortgages make sense over time. In fact, he urges many homeowners to wash the slate clean.
“I say pay off your mortgage as long as you have enough liquid assets on hand,” Roth said.
Roth guides clients through two sliding doors: with and without their mortgage.
Under Scenario No. 1, you have a $400,000 mortgage at 4% interest. You pay $16,000 in interest and may get a $4,800 tax deduction at the 30% marginal tax rate. Your net cost: $11,200.
Meanwhile, you invest $400,000 in a conservative bond fund paying 2.5%. You earn $7,000 after a $3,000 tax bill.
Under Scenario No. 2, you pay off the mortgage and lose the $7,000 in after-tax bond interest. But you save $11,200 in after-tax interest payments. You come out ahead by $4,200.
Applying his advice, Roth concedes that consumers will generally pay more in taxes. And that can stymie both taxpayers and their accountants.
“I do get pushback from CPAs who are trained to lower taxes,” he said. “But the goal is to make more money after taxes.”
Furthermore, taxpayers may not necessarily take full advantage of the mortgage interest deduction. For those with relatively modest incomes, some of the interest deduction may not help as it only gets them to the standard deduction.
Wealthier individuals face different hurdles. The mortgage deduction is generally capped at loans up to $1 million for those married and filing jointly. And even if taxpayers don’t hit the cap, they may start to lose the deduction because it phases out for high earners.
When Roth makes the case for paying off a mortgage, clients often balk at first. Some of them confess that they wouldn’t “feel like an adult” if they didn’t have a mortgage, he says with a laugh.
“Usually, I get some resistance,” he said. “But I’ve never failed to convince all of them, once they see the benefits.”
Roth emphasizes that his recommendation only applies if individuals can deploy their funds to buy bonds — or other conservative investments such as a five-year CD.
“If somebody is 100% in stocks and doesn’t believe in bonds, that can be an argument against paying off your mortgage,” Roth added. It’s the virtually risk-free return from buying a high-quality bond or CD that makes his plan workable.
He cautions that another risk of ridding yourself of a mortgage is that you lose access to that cash. Even if you’re sloshing in liquidity now — and you’re comfortable forking over a hefty sum to settle up with your lender — you may unexpectedly need the money later.
Accumulating a rainy-day fund can help. You might even make monthly payments into a savings account, just as you used to pay your loan-servicing firm.
In the 13 years since he launched his practice, he says that dozens of satisfied clients have taken his advice. And they come away happy.
“They often tell me, ‘I can’t believe someone didn’t tell me this earlier,’” he said.