Living life debt free is a great feeling, however, there may be reasons to consider carrying a bit of debt even if you have the resources to live without it. In the end you may decide the psychic benefits of having no debt outweigh the advantages, but before you pay off your mortgage consider all the advantages of retaining it.

Economics: Remarkably, today it is possible to actually make a positive spread on your mortgage. At the time of this writing a 30 year fixed rate mortgage of $500,000 is available at a rate of 5.75%. Assuming a 40% marginal tax rate, your actual cost would be closer to 3.45%. Today it’s possible to invest that money in a AAA rated California Municipal Bond that yields 5.65% tax free for the next fourteen years (Compton, CA 8/01/18). That nets you more than 2% tax free, or about $10,000 on a $500,000 loan. Given the high rating on this bond and the fixed rate on the mortgage, this strategy caries very minimal risk. For those who are willing to take on more risk, investing the loan amount in stocks could yield even higher returns over the life of the loan. On the other hand, if you continue to hold your mortgage but merely keep the proceeds in a money market account, then you are effectively giving up the bulk of the benefit of keeping the loan.

Forced Savings: In my example above, I have chosen a zero coupon municipal bond that pays no actual interest but rather increases in value until maturity. By making the mortgage payments and accruing interest to the bond rather than receiving it as a cash payment, you are in essence forcing yourself to save in a very tax efficient manor.

Credit Benefits: While most individuals who have no debt can easily borrow money, the fact of the matter is that many banks prefer to see a track record of modest borrowing and timely repayments. In certain circumstances if you have not held any debt for a number of years you may be faced with additional scrutiny if you later do attempt to get a loan. This is especially true if you are retired or have started working less such that your earned income numbers are relatively low.

Inflation Hedge: Simply put, inflation allows you to pay back your loan with dollars that are worth less than they were when you borrowed the money. If you have invested the proceeds wisely you have an excellent chance of keeping pace with inflation but you’ll still only have to pay the face amount of the loan. The trick here is to take out the loan when inflation is low because once lenders get a hint of a spike in inflation they will immediately raise their borrowing rate making this option much less attractive.

As you can see there are numerous reasons why paying off your mortgage is not automatically the best strategy. It can be worthwhile to give the payoff option some thought before writing a check. Please feel free to contact me if you would like to take a closer look in the context of your specific situation.

Randy Gridley

November, 2004