6 Reasons the Rich Should Pay Off Their Mortgage

APRIL 25, 2016
James M. Dahle, MD, FACEP
Home mortgage, personal finance, investingMost Americans have a financial goal to have a paid-for house. Many would even like to pay the house off in less than a standard 15-30-year time period. However, the truth is that most Americans probably shouldn’t be paying off their mortgage early. This is because they usually have a better use for their money. On the other hand, it is far more likely to be the right move for a wealthy, high-income professional. This article will detail six reasons why.

1. Compare to a Taxable Account
Joe Average has a household income in the $50,000-100,000 range. He is almost surely not maxing out a 401(k) ($18,000 employee contribution if under 50) and a backdoor Roth IRA for himself and his wife ($5,500 each). That would require a 29-58% savings rate, which is extremely rare at any income, but particularly for the middle class. Thus, if he chooses to pay down the mortgage with his extra funds, he is by definition passing up the opportunity to have tax-protected growth for decades, an extremely valuable benefit. A high-income earner on the other hand, especially one who saves enough to now be wealthy, is probably maxing out all available tax-advantaged retirement accounts. So when he considers paying down his mortgage, he is comparing that to investing in fully-taxable, non-qualified investing account, which is not nearly as good a deal.

2. Higher Tax Rates
Even if a low earner is investing in a taxable account, he may pay very low taxes on those earnings. If he is in the 10% or 15% bracket, he pays a rate of 0% on his long-term capital gains and qualified dividends. A high earner, however, is paying at least 15% on those earnings, and possibly as much as 23.8% (not including state income taxes.) This lowers his after-tax return such that his mortgage starts looking even more attractive.

3. Lower Marginal Utility of Extra Wealth
Many advisors recommend carrying low interest rate debt on purpose so you can invest instead and hopefully earn a higher rate. Aside from the obvious error of not comparing apples to apples risk-wise (they should be comparing the after-tax mortgage interest rate to the after-tax return on a very safe investment such as treasury bonds, CDs, or a municipal bond fund), they are ignoring the marginal utility of wealth. When you are very poor, a little more wealth makes a huge difference in your life economically and psychologically. As you build wealth, that difference gets smaller and smaller. So for a wealthy high income earner, arbitraging a low interest rate against a higher return is simply less useful. Many times these higher earners choose to lower their risk rather than increase their returns.

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