Many of my clients have considered, at one time or another, the wisdom of paying off their mortgages. It seems like a smart decision, right? After all, they’d be saving all those interest payments and would get to live free and clear in their own home.
Unfortunately, this isn’t really the case. While it’s true that they will save money on interest, it’s usually not a great idea—especially if they want to pull money out of their retirement accounts to do so. It’s likely that, in the course of your advice-based planning career, you’ll get asked this question at least a few times and it’s always good to have an answer prepared in advance.
Here is the advice I often give my clients who ask this question. Hopefully, this information will help you formulate an effective and supportive response to your own client inquiries.
Conflict of Interest
When one of my clients brings up the issue of using investments to pay off their mortgage, I always make sure to disclose to them the potential conflict of interest as an advisor. After all, I am paid for the amount of money that is invested with me and I have no financial interest in their mortgages. I never want my clients to think I’m advising them against paying off their mortgage simply so I can retain more of their assets.
Once I have disclosed this, I can give them my advice on why I think it’s a bad idea. This is my responsibility as a fiduciary and my obligation as a mentor. Properly clarifying the potential conflict of interest is always the best way to start a conversation about paying off a mortgage by liquidating invested assets.
Rate of Return
Some of my clients are not aware that a mortgage is likely the cheapest money they will ever borrow. Not only is the interest deductible, but it could have an effective cost of less than 4% depending on the tax bracket you’re in. Compare that to the interest rate on conventional loans or credit cards and most of your clients will realize what a good deal they are getting.
The next step is to help your clients realize what their ROI is on their retirement accounts and other investments. A diversified portfolio usually shows returns much higher than their mortgage interest costs them. Though this is oversimplifying the matter a little, ask them why they would trade in money they’re making a good return on to pay off something that is costing them much less. This is often an ah-ha moment for many investors and something they’ve not really wrapped their minds around previously.
No One Ever Gets to Live for Free
When most people think about paying off their mortgage, they get a false sense of security. They envision living in their home for free and eliminating a huge debt that can then be used for other retirement expenses. However, what many don’t take into consideration is that no one ever gets to live in their home for free.
Even if your clients paid off their mortgage, they would still need to pay property taxes. If they own a $300,000 home in the Omaha area, this amounts to around $523 per month or over $6000 per year. That’s not an insignificant amount, especially if you are on a fixed retirement income. Make sure your clients realize this payment won’t go away even when their mortgage is paid off.
If you’re familiar with human behavior models, you know that individuals tend to seek safety, comfort, and stability as one of their basic levels of need. They often equate a paid off mortgage with increased security when the truth is that they will be compromising their security by taking money out of a diversified portfolio.
If your clients want to pay off their mortgage, it’s not always a bad idea. It all comes down to how much money they have in savings, how long they plan to keep their home, and how close they are to retirement. However, in my experience, it’s almost never prudent to pull money out of their retirement portfolio to do so.
If you’d like more advice on addressing common questions from clients, please give me a call or send me an email. I’d love go help you out.