Many Americans hold as a top financial priority – a paid-off home because of the peace of mind that comes with it.
Peace of mind is a strong emotion, and if you find great relief in discarding your mortgage payment, I’m completely supportive of your goal and encourage you to pursue it with vigor.
I will however, challenge you to consider the three financial consequences of paying off your home:
1. Since mortgage interest is tax deductible for most people, mortgage-free often means a tax increase. And since many states offer ‘mortgage exemptions,’ it can also mean a property tax increase.
2. If your home is worth $250,000 – then a paid-off home is like taking $250,000 of cash – stuffing into a coffee can – and burying it in the backyard. That’s exactly the return on investment you get on what is likely a large component of your overall net worth. Remember, it is the home (the asset) that can go up in value, not the equity.
3. Paying off the home imposes a huge liquidity risk on us. Perhaps the most underestimated and devastating of the financial risks, liquidity risk is a measure of the time and cost of converting an asset into cash if needed. Turning home equity into cash can be accomplished by borrowing against it (which requires a qualified borrower at a time where the borrower’s qualifications may be at their weakest); or selling the home, which is both a lengthy and expensive process.
But there’s one more piece of logic that belongs in the conversation. Many of the same folks who hold up ‘mortgage-free’ as a lofty financial goal are building and accumulating debt of another kind – without even knowing they’re doing so.
Those are the people with qualified plans like IRAs, 401ks, and others. And the accumulating debt is the deferred tax liability inside the account. Deferred taxes are debt. They are the equivalent of a lien against a qualified account in exactly the same way the mortgage lender holds a lien on a home.
If I have $1,000,000 in an IRA – the reality is – I really only ‘own’ the after-tax equivalent – say $700,000 if my tax rate is 30%. The rest belongs to Uncle Sam – I’m just ‘holding’ it for him, temporarily. So if my account grows by 10%, my portion of that growth is $70,000, and my deferred tax liability (debt) grows by $30,000.
Financial decisions and emotional decisions too often get inter-mixed. It’s human nature, and frankly, in many cases, they should. Just be sure you’re thinking things through from all angles rather than stopping at the easy or the obvious. Bad outcomes can result when the emotionally convenient trumps the financially prudent.
