Gauging Your Mortgage

Note: In my Feb. 23 article, Six Tax Moves for $10,000, please be advised that when I was discussing credit card debt refinancing, I was referring to taking out a home equity loan or line of credit, the interest on which would be tax deductible in some cases. I apologize for any confusion.

Here's a question I get all the time: "I've run into a little extra cash, and my current income is taking care of things. Should I be paying off my mortgage?

Heck, every financial column you read talks about avoiding or getting out of debt, and how there's too much of it going around.

But that's consumer debt -- the typically high-cost kind used to fund all sorts of short-term purchases.

So a mortgage is debt, too, right? Yes, but it isn't necessarily bad debt. Here's what I tell people who ask me about paying off their mortgage: Don't, if you can do better with your money.

Sounds good in theory, but you still have the itch to host that mortgage-burning party and light the match. The question is, should you?

Turns out it's a complex, multisided financial choice with no cut-and-dried solution. While my simple answer is a good place to start, it really depends on your tolerance for debt, retirement vision, investing style, age, tax situation and even where you live.

In a moment, I'll give you my list of reasons whether to pay it off. But first, here's some background.

On one hand, a mortgage is cheap compared with almost any other source of personal capital, especially considering tax savings. A 6% mortgage effectively costs 3.9% after mortgage interest deductions for those in a combined 35% tax bracket.

On the other hand, paying off a mortgage is almost identical to buying a risk-free bond paying a rate equivalent to the mortgage rate. For many investors, particularly those already with other more-aggressive investments, this sounds pretty attractive.

On the other hand, paying off a mortgage is almost identical to buying a risk-free bond paying a rate equivalent to the mortgage rate. Your return is the interest you save by not making a payment. For many investors, particularly those already with other more-aggressive investments, this sounds pretty attractive.

I should note that mortgages aren't as cheap for those in lower brackets.

Some in less-expensive inland markets may not have enough mortgage interest to exceed the standard deduction ($10,700 married filing jointly). And taxes are not the only consideration -- spending an interest dollar just to save 35 tax cents never makes sense.

Here's the biggie: retirement. Obviously, having a mortgage adds a large expense burden during a time when every dollar must be built to last.

There can be a double tax whammy. Taxes must be paid on precious 401(k) or traditional IRA dollars withdrawn in retirement to service the mortgage, while the interest deduction may be worth little to nothing at low retirement income levels.

Still, according to the 2004 Federal Reserve Survey of Consumer Finances, some 32% of all households reach age 65 still carrying a mortgage.

Paying off a mortgage used to fly in the face of financial flexibility. If you paid off the mortgage, it was like locking cash into a vault and throwing away the key. It wasn't coming out again until you sold the property.

Click here for the video version of this story from Jennifer Openshaw.

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