The new tax laws enacted at the end of 2017 changed the potential tax benefits of homeownership for many. Two major changes include:
- The new rules cap the amount of state and local taxes (SALT) that can be included in your itemized deductions at $10,000. The main components of SALT that will affect most people are state income taxes and the property taxes on your home. In many areas, $10,000 in annual property taxes alone is not uncommon.
- The standard deduction has been increased to $12,000 for single filers and $24,000 for those who are married filing jointly. This means that for those whose total itemized deductions are less than these amounts, taking the standard deduction is more beneficial.
The combination of these two changes means that for many taxpayers, itemizing deductions will no longer be the best choice as the combination of the now limited SALT deduction and mortgage interest deduction will fall below the standard amount. Some advisers are now suggesting that those who can should consider paying off their mortgages.
As a financial adviser, my answer to whether a client should pay off his or her mortgage depends upon the individual’s situation. This is not just a tax decision; considerations go well beyond that. Here are a few things to think about when evaluating your unique situation.
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Emotional versus financial issues
Our homes are more than just a financial asset. This is the place where we live our lives, where our family memories are made.
For most people, having paid off the mortgage by retirement is a good idea. Not having a mortgage payment during retirement can make your retirement savings, Social Security, pension and other retirement assets go further.
Many retirees want to downsize at this stage of life. Ideally, they will sell their home, and use the proceeds to fund a substantial down payment or to pay cash for a smaller home with some money left over to add to their nest egg.
For those still accumulating assets for retirement, however, the sense of security of living in a paid-off home should be weighed against whether paying off your mortgage is the best use of this money.
Trading liquid assets for illiquid assets
Eliminating a mortgage payment can be attractive. Who wouldn’t want to get rid of a sizable monthly outlay? While a home is many things, it is still an investment.
Taking $100,000 or $200,000 or more and paying off your mortgage is an investment decision. By doing this you are saying the best use of this money is tying it up in your home, which is an illiquid investment.
Before you do this, ask yourself:
- Might I have a need for this money over the next few years? If it is tied up in a home, accessing it will be difficult at best. Before you pay off your mortgage be sure that you have sufficient liquid assets to meet any anticipated or unexpected expenses.
- Will paying off your house offer the best return on this investment? Would you be better off taking this lump sum and investing it elsewhere, perhaps in a diversified portfolio tailored to your unique situation?
Over the 23 years ending in 2016, the compound annual growth rate (CAGR) for stocks was 9.66%. This compares to 3.81% for home prices nationally over the same period. This is not a uniform rate and price appreciation varied, but returns on homes still paled in comparison to the returns on equities.
Housing prices don’t always go up
While housing prices have been strong in many areas of the country this year, that has not always been the case. In some areas housing prices still haven’t recovered since the housing bubble burst a decade ago. Ask yourself, will taking liquid assets and paying off the mortgage balance provide a better return on investment than investing those funds elsewhere?
What’s the right decision for me?
Everyone’s situation is different. While the security of a paid-off mortgage can be tempting, it should be weighed against other uses for the money. These might include other investments or simply having a sufficient emergency fund.
As with most issues, tax considerations are not the only driver of this critical financial decision. Financial decisions are complex and should almost never be determined by just one factor.
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