Q: My husband and I are 60 years old and we have a $100,000 mortgage with about six years left on it. Should we just use some of our investments to pay it off now? It feels silly to be paying interest at this stage in our lives.
A: Based on the limited information you’ve given me, I am going to need to make a few assumptions. First off, it is important for you to recognize you are currently playing a game of leveraged investing. This has a bad ring to it, but don’t let that scare you. Millions of households are playing right alongside you!
When you take on a mortgage, you are simply borrowing money against a piece of real estate. Like the game of monopoly, you’ve asked the banker for $100,000 in cash and you’ve put your home up as collateral.
Based on the information you’ve given me, it sounds like you also have at least $100,000 invested in some account. You should view this portion of your investment portfolio as completely funded with borrowed money.
With this portion of your portfolio, you could draw it down completely to pay off your mortgage at any time. On the other hand, you could choose to keep it invested with the goal of making more return than the cost of your mortgage debt. By choosing to keep the mortgage in place, you are clearly playing an investment game on margin. Despite what we were told as kids, the true object of playing a game is to win. Here is how I’d advise you judge your own odds of winning this game.
Let’s assume your mortgage carries an interest rate of 4.5 percent and your combined marginal tax rate is about 30 percent. Therefore, the after-tax cost of your mortgage debt is about 3 percent. Can you make more than 3 percent in your investment portfolio, after all expenses? Before you quickly answer yes, a deeper dive into the numbers might help.
If you’ve hired an adviser to manage your money, your portfolio will need to earn an additional 1 percent (sadly, in some case, way more than this) for you to see the 3 percent. Now, you are up to 4 percent. To this, you also probably need to add yet another 1 percent to satisfy Uncle Sam. In total, for you to earn a 3 percent after-tax return, your portfolio will probably need to earn about 5 percent just to break even in the game. However, the goal was to win, not tie!
Now, if you decide to pay off your mortgage and just forfeit the leveraged investing game, it is important to understand that the budgetary windfall you’ll feel each month — with your mortgage payment gone — should be saved, not spent.
If you don’t have the discipline to save that monthly windfall, you should consider a less-than-obvious advantage of just methodically chipping away at your mortgage over time — automatic forced savings.
Jason P. Tank is a Chartered Financial Analyst and co-owner of Front Street Wealth Management, a fee-only wealth advisory firm located in Traverse City. He encourages questions and comments about future columns. He can be reached at 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com.