Pros and Cons of Mortgage Prepayment by Seniors

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May 10, 1999

Whether or not seniors should prepay their mortgages depends on a range of circumstances that vary from case to case. These include their total wealth, age, and tolerance for risk. The two cases that follow are illustrative.

"I have $30k remaining on my 8% mortgage, which has less than 5 years left, and I also have $10k of other loans at 12%. My stock portfolio is several times larger than my debts. I am considering the following options: a) Liquidate stocks to pay off the mortgage balance, which saves the $1,000 per month payment. Then use $500 a month to repay the 12% debt and $500 to invest in stocks; b) Liquidate stocks to pay off the 12% loans, saving $500 per month which would be invested in stocks; or c) Don't prepay any debt and watch the stocks grow at 20% annually. I am 50 years old and want to retire in 13 years…

The correct answer depends on how much risk you are prepared to take. If you were certain that your stocks would continue to yield 20%, it would be your option c. You wouldn't pay off any of your debt before you had to, and in fact you would refinance your mortgage for the maximum amount you could get and put the cash you take out into stocks. The sole reason you are contemplating repaying debt that costs substantially less than 20% is that the 20% is not to be depended on, especially in the short-term. Option c is the riskiest course of action.

The next riskiest is to pay off the 12% loan, your option b), which is what I would do. Borrowing at 12% to hold stock is too much of a gamble for my taste. If you were really risk averse, you would pay off all your mortgage as well.

Your first option, paying off the mortgage alone, makes no sense. If you are going to repay debt, you pay off the higher cost debt first.

"I have a $49000 mortgage at 8.75% with 28 years to run…At my age (76), is it worth it to me to refinance? I have no debt other than this, and have about $170,000 in cash, Treasuries and a money market fund. I need more spending money."

Rather than refinance, I would pay off the mortgage in full. Viewed as an investment, repaying a mortgage yields a risk-free return equal to the mortgage interest rate, which in your case is 8.75%. Since you have $49,000 in liquid assets earning far less than this, it is a no-brainer.

If you were wealthier, and had a significant portion of you wealth invested in the stock market earning 12-18%, I would probably counsel you to refinance the 8.5% loan. But you have limited wealth and have elected to invest it conservatively, which for someone of your age makes sense. Prepaying your mortgage in full is consistent with a conservative investment policy.