Paying off a mortgage prior to retiring is a common goal for many homeowners. Buy, while the desire to retire debt-free is understandable, it may not always be in your best interest, particularly when a large withdrawal from your TSP account will be required to retire your mortgage before it matures.
If you have the money in your TSP account to pay off the balance of your mortgage and the taxes that will be generated by the withdrawal, you may be tempted to take one or more large distributions for this purpose. In this case, you should think of paying down the mortgage as an alternative investment to your investment in the TSP’s funds.
One thing to consider in this decision is the relative benefit you expect from each of these alternatives, and the certainty of enjoying those benefits. If you have a fixed rate mortgage the return on this investment will be the after-tax cost of the interest you will pay. If you have a fixed If rate mortgage with an interest rate of 5 percent and 10 years remaining, and you use the Standard Deduction on your tax return, your pre-payment “investment” will be like buying a 10year CD that pays 5% in taxable interest per year. You should compare this expected return on your investment in paying down the mortgage with the expected return on your investment of this same money in your TSP account. If your TSP account is managed well and the mortgage interest rate iS low, you may earn more on your TSP funds than it takes to cover the payments.
You should also consider the effect of taking money from your TSP account to pre-pay your mortgage on your liquidity. While it’s attractive to reduce or eliminate your monthly mortgage payments, you’ll have to take many monthly payments worth of money from your TSP account to do it. Have you considered whether you might need this cash for expenses later, when you are no longer able to qualify for a mortgage on attractive terms? You don’t want to wind up rich in home equity, but unable to free up the cash you need to pay your bills without selling your home.
A frequently overlooked benefit of a fixed-rate mortgage is what I like to call its “option value’. You have the option of retiring the loan if it becomes unattractive. A 10 percent mortgage in a 5 percent market is unattractive to you, and vou are free to repay the loan. A 5 percent mortgage in 10 percent market, however, is unattractive to the bank (and attractive to you), but bank can’t make you repay the loan early. This might be the only advantage you will ever have over a banker and you should think carefully before giving it up. If you can borrow money at 5 percent and invest it at 10 percent, you’re making a profit. If you have a 5 percent mortgage, you’re already halfway there.
Written by Mike Miles
For the Federal Times
Publication August 6, 2019