Dear Big Move,
I am a woman in my 50’s with a nice nest egg (about $4 million) divided amongst various investments.
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I earn between $200,000 to $400,000 per year, depending on how well my business does. I hope to sell it within the next few years and understand that I’ll be able to do an early retirement (though I’ll probably get bored and start working again). My annual expenses are around $75,000, and I do not feel that I am lacking in any way.
I own a home that is worth about $1.75 million, with a $500,000 mortgage.
My business has been doing well lately, and I am able to take nice owner distributions of $10,000 to $30,000 per month.
Question is should I use the extra money to make principal payments on the mortgage? It is at a 2.75% rate and my investments are all returning at least 6%, so I’m not in a huge rush to do this.
But, I also hate the idea of paying a bank hundreds of thousands of dollars in interest. Then again on the flip side, my interest payments are deductible on my tax return.
What should I do?
Dreaming of Debt Freedom
Dear Dreaming,
First of all, kudos to you for achieving so much — $4 million in savings, on track for an early retirement, owning your own home, and being your own boss. You know what it takes to become a financial success, and are making smart choices.
As to whether you should pay off your $500,000 in outstanding mortgage debt or not, you weigh the dilemma of being debt-free with the joy of holding a very low mortgage rate of 2.75% that you may not see again for a very long time (or even in our lifetimes).
But there’s no pressing need for you to pay off that debt early, when your interest rate is significantly lower than the prevailing 7%-plus.
Here’s why:
First, you still have some years to go in the labor force before you retire, so the tax benefits of a mortgage are worth keeping. So “take advantage of using the itemized rather than the standard deduction on your taxes,” Jody D’Agostini, a certified financial planner and a financial adviser with Equitable Advisors, told MarketWatch. Even though it requires more documentation to support your expenses, “you are in a relatively high-tax bracket, so this can mean some significant tax saving,” she said.
Now owing debt to a bank may feel like a tether you want to cut sooner rather than later. There’s no feeling like owning a house free and clear. But “your interest rate is even less than inflation at this point in time. I would not be in a rush to pay it back,” D’Agostini said.
To be sure, pre-paying your mortgage is not going to be a big burden for you. If this is a major financial goal for you, you should absolutely pursue it. You can make additional payments to your principal between now and when you retire, chipping away at the principal payments. You have a $4 million nest egg should an emergency arise. And your portfolio will keep growing in the years ahead, D’Agostini added.
But you need to decide if this is worth it because, as you said, you are not in a huge rush to do this.
In fact, this mortgage debt at 2.75% “could be your friend,” D’Agostini added.
“Think of it as the bank allowing you to grow your investments at that higher rate. If you are planning to move from the home when you retire, then again, I would not be in a hurry to pay it off,” she added. “You already have significant equity in the home. Markets have recently been favorable, so your upside might be better than the interest savings from a prepayment.”
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