By Quentin Fottrell
“I’m maximizing my retirement accounts – IRAs and 401(k)s – and looking to retire in less than 10 years”
I currently owe $300,000 on my house with a 2.5% 30 year mortgage. I am maxed out on 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, which will allow me to pay for the house.
I am in a very lucky position. Should I pay it back or should I invest the money?
You will save considerable interest by paying off your mortgage early, especially at a rate of 2.5%. Millions of homeowners would kill for that rate.
Of course, it has a lot to do with luck. Take a moment: the 30-year mortgage rate is currently above 5.5%. The consumer price index rose 8.5% in July from a year earlier, and the closely watched ‘core’ inflation measure – excluding volatile food and energy – hovered at 5.9 %. With an interest rate of 2.5%, you are already making money just by living your life.
As my colleague Aarthi Swaminathan said, “As the price of their car, gas, electricity and other expenses go up, this homeowner will also see the value of their house go up with inflation. Yet his mortgage rate stays the same because it’s not inflation adjusted, which means they’re still paying the same rate as before inflation.”
Overpay if you can, especially early in the loan term when interest payments are higher. Depending on the terms of your mortgage, you may be limited on the amount of overpayment you can make (10% in some cases), and as infuriating as it may sound, there may be an overpayment penalty. In your case, that could be a good thing.
Your tax-efficient retirement savings at, say, 6% will do the heavy lifting for you, offsetting your 2.5% interest rate, assuming you have a healthy 401(k) and IRA. Talk to a financial adviser and make sure you would still have enough to live comfortably and pay off your mortgage and/or downsize.
Speaking of financial advisors, Larry Pon, a financial planner based in Redwood City, Calif., says that many people who have extra money face your dilemma, and there’s no right or wrong answer. He agrees with me: “I would do both. I wouldn’t pay off the mortgage and I wouldn’t invest the inheritance aggressively, but I would do a combination.”
“Since you are 10 years away from retirement, for inheritance, I suggest investing with a moderate allocation, which is somewhere between 50/50 and 60/40 for stocks and bonds. This portfolio can generate enough income to increase your mortgage payments,” Pon said. “This means you may not notice any difference in your personal cash flow and will pay off the loan in 10 years.”
Keep maximizing these counts. “I’m assuming you’re over 50, so you can put $7,000 in an IRA and $26,000 in your 401(k). I’ve been doing this for 36 years and I’ve yet to meet anyone who has put too much aside for his retirement,” Pon added. “I strongly suggest that you continue to maximize your retirement plans so that your retirement is more secure.”
Pon describes the advantages and disadvantages of investing and paying off the mortgage. Here are its advantages: 1. More mortgage payments. 2. Debt repayment is a risk-free investment. “You’ll save at least $1,200 a month, which means instead of paying the mortgage, you can redirect your payment amount to your savings.” 3. “It will make your retirement more secure.”
And the cons: 1. Your mortgage rate will probably never be this low again. 2. If you invest the $300,000 instead of paying off the mortgage, you will bear the investment risk. 3. “Even in today’s market, your returns on investment are expected to be over 2.5%. It’s not risk free or guaranteed, but taking some risk will get you a better return.”
If it was me ? I would repay the loan. I don’t like debts. We spend the first part of our lives desperately trying to get a mortgage, and then the rest worrying about paying it off. They are a necessary, if sometimes unhealthy, obsession. Mortgages give us something to focus on besides the other “M” word: our mortality.
Still, life would be sweet with a paid off mortgage. Until the next obsession arrives.
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