Prepaying a Mortgage Has Its Payoff For Most, But Not All

Sometimes, it's the simple questions that spark the liveliest discussions.

In this case, the question we posed to readers on our Personal Finance forum was "Did You Prepay Your Mortgage?" There are strong cases to be made for answering yes or no. For those in or soon to enter retirement with the means to do so, paying off a mortgage early can be a great way to reduce monthly expenses. On the other hand, using money that might otherwise be invested in the market to pay down mortgage debt poses a potential opportunity cost if market growth outpaces the interest rate (and after factoring in taxes).

The question of whether to prepay a mortgage is particularly interesting these days, with mortgage rates near all-time lows and the stock market engaged in a bull run that recently passed its sixth anniversary. Whereas paying down a high-rate mortgage may have been a more obvious choice in decades past, in more recent years someone who invested the money in stocks instead may well have come out ahead, at least financially (peace of mind being another matter). Of course, bull markets eventually end, and interest rates will eventually rise. But it's clear from what readers have to say on the subject of prepaying a mortgage (you can read the full conversation here) that it's an individual choice as much as anything. The right decision for one person may not be right for another.

'We Love the Sound of the Term 'Free and Clear'' The overwhelming majority of readers responding to our question last week said they'd paid off their mortgages early or were in the process of doing so. For some, it was an easy decision.

"Did we prepay our mortgage? Yes. Why? We love the sound of the term 'free and clear'!" wrote Dan6912.

Many mentioned the peace of mind that comes with knowing one doesn't have to pay a mortgage anymore.

"With five years remaining on a 5.5% mortgage, we paid it off," wrote tmregal. "We're about to retire and I wanted no debt. There's both a financial and psychological payoff in having done so."

More than one reader, in fact, said that paying off their mortgage early was, as Walls4 put it, "one of the best financial moves we ever made."

"Now, as retirees, except for taxes, utilities, and maintenance expenses, our investment/401(k)/Social Security/rental income is largely discretionary (cars paid for as well)," Walls4 wrote. "Free cash flow works for personal finances just as it works when evaluating securities."

In some cases, readers said they saw paying off their mortgage as a prudent financial move, at least as compared with using the money to invest in stocks.

"After watching what happened to many portfolios in 2007-09, we decided to pay off the mortgage," said ggold1146. "No matter what happens with our investments, we will always have a comfortable roof over our heads."

Dawgie felt the same way, writing, "Paying off a mortgage is a guaranteed return at whatever rate your loan is set at. Investing in the stock market will always be somewhat of a gamble. During the period in which we paid off our mortgage, the stock market crashed twice and returns were less than what we saved by paying off our loan. With bond yields currently at record low levels and stock valuations very high, I am not convinced that investing in stocks/bonds right now will earn more than simply paying off your mortgage sooner."

Many readers who prepaid their mortgages raved about how great it feels to be debt-free, but for at least one that peace of mind held special significance.

Marymary wrote, "Eighteen months after my retirement, I was widowed. I wanted very much to stay in the home we built and planned on staying in in retirement. Because household income would be reduced by one Social Security check, I decided my capital would best be spent paying off the modest mortgage balance. For the most part, I'm a moderate investor and there was nothing I could feel comfortable investing the money in that would pay me enough to make the mortgage payment. Now, four years later, with no debt whatsoever, I think it's one of the best financial decisions I could have made. I don't require as much income from my investments and feel secure that no matter what the market does I can manage well."

Then, there was javajoe, who said that prepaying the mortgage was a decision made with his family's future in mind.

"We paid off our house in our mid-30s," he said. "It provided the peace of mind we (but especially my wife) needed to quit her job and stay home with our two little kids. Basically trading some financial capital for relational capital."

'Achieving This Middle-Class Milestone' In some cases, readers told of how paying off their mortgage early allowed them to ramp up their retirements savings.

For example, Billbruss said that, "In 1998, we took out a 6.75%, 15-year mortgage. After one refi in 2002 at 5.50%, we came into a little inheritance money and paid it off entirely in 2006. The money formerly used for the mortgage was rededicated to retirement savings, allowing us to max our 401(k)s and Roths. It seems to have worked out well. We will be retiring in two months' time with a nest egg I am confident would not be anywhere near this size had we not paid off the mortgage and maxed our savings. I count it as one of the smartest things we've done, psychologically and financially."

Some readers, including phil56, said that prepaying required making some sacrifices.

"We prepaid ours over 21 years," he wrote. "We started at 7.25%, refinanced at 5.75%, and shed private mortgage insurance, and then again at 4.75% for 15 years. We added $500 a month for the last few years when we were beyond college costs. My spouse was working then and insisted we do it for peace of mind. I am glad we did as it created several options as we consider early retirement. True, we could afford to prepay, but we had to do without some things like new cars and costly vacations to make it happen. We haven't had a mortgage burning party yet, but it was sweet to get a letter from the bank holding the loan congratulating us on achieving this middle-class milestone."

Readers also told of prepaying using different methods and at different speeds. For example, many were like wilbodave, who is taking the slow and steady approach.

"I'm about eight years into a 30-year mortgage," he wrote. "From the first payment, I've added an extra $100 per month. It works out to roughly one extra payment per year. I'd like to have it paid off before retirement, about 15 years from now. After refinancing at 3.75% fixed, I've read the comments of people who advise to put the extra cash into the market at a higher rate. That might make sense, but I get a lot of satisfaction seeing my principle balance shrinking at an ever-accelerating pace. And while I understand that it might make sense to invest the extra cash, I don't like the idea that I'm paying thousands of dollars every year in interest."

Others described paying down their loans far more quickly.

"My wife and I did prepay, for a long period adding $1,000 a month until the loan was paid off in 15 years instead of 30," said JBrown. "I viewed it as an alternative to bonds, offering a yield comparable to 30-year Treasuries with much less principal risk."

For flhtc9, the pay-down was even faster.

"When I was 47 years old, I took out a 30-year mortgage," the commenter said. "The thought of paying a mortgage when I was retired did not appeal to me. I paid the mortgage off in 12 years. I am now happily retired with no mortgage."

'It Makes No Sense For Me' Naturally, not everyone agreed that prepaying a mortgage is the way to go. Those opposed to the idea often mentioned today's low rates as a reason not to pay off the mortgage, the thinking being that the money could be put to better use elsewhere.

JimD2 wrote, "With a mortgage of less than 4%, I prefer to invest any extra money in the market, as I can do much better than the 4% I would make from prepaying the mortgage."

"I have taken the 'money is on sale' approach," wrote John883. "With fixed mortgage interest rates so low, I allocate extra money to IRA/401(k)-type investments. I am only in my 40s and plan to pay the minimum amount [on the mortgage] for the next 20 years or so. Given the long time horizon and somewhat high likelihood of inflation, the value of my mortgage debt should diminish [in real terms] as inflation progresses. I have no shame in owning a mortgage."

Modpod was even more adamant about not prepaying.

"Heck no! It makes no sense for me," modpod wrote. "... I am 68 years old, a self-employed consultant, and mostly retired. I do not have a savings account and have never purchased a CD (the money type). For the last 20-some years, all of my available cash has been invested in a SEP-IRA. I also carried over from previous employment a 401(k). I'm self-managing all of the investments, most of them in mutual funds--primarily index stocks and intermediate bonds. My liquid cash from all investments is $932,000. ... I now carry a $250,000, 3.8%, 15-year mortgage. ... In a review of my investment records [for the past 10 years] ... I noted that the S&P 500 Index measured a return of 8.01% while my SEP returned 7.95%. The bottom line is that I have flexibility to pay off my mortgage if I want to (although suffering a large tax payment in doing so). By not prepaying, the capital and dividends of my investments accumulate tax-free, and there is the bonus of tax relief from the mortgage interest."

In fact, several readers who said they haven't prepaid on their mortgages mentioned the value of the mortgage interest deduction on their taxes as a reason.

"I have about 11 years remaining on a 2.8% 15-year mortgage with retirement about three years away," wrote ConeheadMC. "Will I prepay? No, not yet, and I won't as long as 1) the mortgage interest remains the cornerstone in being able to itemize deductions for income tax filing and 2) I have more attractive investment opportunities with my excess cash flow."

NDinLA wrote, "[Our] income is so high, the home mortgage is the only deduction we have available. If I started prepaying the mortgage, the higher tax would only hurt our long-term investing capability."

Other income tax considerations came into play for other readers, including retirees who said that being able to keep some money invested outside of retirement accounts worked to their advantage at tax time.

"We've considered paying off the mortgage but have not," wrote SilSanders. "Since most of our investments are in regular IRA accounts, if we use up our small taxable accounts to pay off the mortgage, we'll be paying considerable ordinary income taxes [from retirement account distributions] sooner after repaying."

One reader who didn't prepay said he might have--if the lender hadn't been his own mother.

"At the time we built our house in the early '90s, local lenders were not making loans," recalled Myshkin. "If they had been, the rate for a 15-year fixed-rate mortgage would have been in excess of 10%. We approached my mother--a CD- and Treasury-only investor--about a 9.25% 15-year mortgage, on the assumption that it would work out to both of our advantages. We got access and a below-market rate; she got a far better return than would have been possible elsewhere. So far, so good. But when rates declined from those historic peaks, while the mortgage had standard prepayment provisions, I could not bring myself to raise the topic. Mom was dependent on the mortgage payments for her retirement, and I was not about to jerk the rug from under her. So, I repaid every dime of that 9.25% mortgage exactly on schedule!" (Click here for more on how private mortgages and intrafamily loans work, and some of the pitfalls.)

Some comments have been edited for clarity and brevity.