To Pay or Not to Pay?

Posted by on Mar 7, 2012 in Featured Articles. | 0 comments

Author: A. Cole Garcia


Many clients will be facing a mortgage payment well into their retirement.

The phenomena is fairly unique to Americans and until recently was almost never the case.  A very common question I get from pre-retirees is whether using a 401k or IRA to pay of their mortgage prior to or just after retirement is a smart planning strategy.

The answer most often is, no.

There are three reasons why not: 1) The mortgage interest deduction. Most taxpayers can reduce their taxable income by the amount of interest they have paid that year in mortgage interest,2) Interest rates are at all time lows and 3) that the fixed interest rate 30 year mortgage is the greatest thing to happen to borrowers since the invention of compound interest. Yet from a lenders standpoint loaning money at a fixed interest rate over a 30 year period with no prepayment penalty is almost assuredly a bad investment. How can that be. Well we must remember that banks not only loan money but they also borrow money in the form of savings accounts and Certificates of Deposit (CD’S).

For example back in 1982 interest rates were 15%. If a bank loans money to you to buy a house at 15% interest with no prepayment penalty you will most assuredly re-finace that mortgage when the rates drop. But the banks are still having to pay out interest at 15% on loans it made in the form of CD’s. On the other hand if you borrowed money from the bank today at 4% will you be willing to refinance when the rates start to rise? No of course not! But the banks will be paying out higher and higher interest rates on the money they borrow. For a bank the 30 year mortgage is a lose/lose investment. So why do they do it? If you guessed Fannie Mae and Freddie Mac, give yourself a gold star as you are correct. The only reason banks offer 30 year fixed rate loans is because of the backing by the US taxpayers.

If you have watched any of the republican debates you have heard Ron Paul, the libertarian congressman from Texas, repeatedly talk about the artificial boom’s and bust’s that the US government creates via the Federal Reserve and Fannie Mae and Freddie Mac. If we look at what is happening with interest rates today we can see that the US government is setting us up for yet another boom and bust.

In its insistence on keeping interest rates near record lows the Federal Reserve is setting the banks up for another bust. When interest rates rise in the future most Americans, the ones who have been able to keep their houses and their home loans, will be paying ridiculously low interest rates while the banks will be having to pay higher and higher rates which at some point will lead or contribute to another round of bank failures and ultimately more government intervention.  In recent history we have had real estate bust’s in the mid 70’s, early 80’s, mid 90’s and we are currently mired in a recession in part created by a real estate bust.

So back to my original question. Does it make sense to take a lump-sum out of savings or retirement plans in order to pay off or pay-down a 30 year fixed mortgage? The answer is almost always NO. As a borrower you could not be in a better position. Coupled with the mortgage interest deduction and the tax liability for liquidating a 401k or IRA, in almost every situation your are better off not pulling assets out of a retirement plan to pay off your mortgage.


As compelling as this may be, the larger question is how to invest that IRA or 401k in order to grow and protect it against the inevitable volatility of the stock market?




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