July 24, 2009 in Mortgages

Dear Dr. Don,

I plan on retiring this year, and I owe $92,000 on my mortgage. It is an adjustable-rate mortgage that was reset on May 1, when the lender lowered my rate to 3.25 percent from 4 percent for one year.

With safe savings rates that are lower than my mortgage rate, should I go ahead and pay off my mortgage and be debt-free? I do plan on selling my house in the next year or so and finding something smaller. Even though I will be retired, I will still have enough money to live on. I’m just not sure what to do.

— Kristy Curtail

Dear Kristy,

My initial reaction was if you’re serious about selling your home in the next year or so, I don’t see the need to pay off the existing mortgage just to save the difference between the effective cost of your mortgage and the after-tax return on your savings. Then I ran the numbers.

Mortgage payoff versus savings
Mortgage Savings account Difference
Amount $92,000 $92,000
Interest rate 3.25% 0.75%
Pre-tax $2,990 $690 $2,300
After-tax (25%) $2,242.50 $517.50 $1,725

The numbers don’t precisely reflect your situation because I don’t know your marginal federal income tax rate, savings rate or whether you can use the mortgage interest deduction on your income taxes. However, it’s likely there’s enough money left on the table for you to consider paying off your note.

Before you do, make sure there’s no prepayment penalty on the loan and that you won’t leave yourself short of liquid funds. There’s a value in having some financial flexibility, so cashing in all of your savings to pay off your mortgage isn’t a good idea. You can capture some of the savings by paying down part of the note.

Read more Dr. Don columns for additional personal finance advice.

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