I am planning to pay off my mortgage this year. Please talk me out of it.
Background and Concessions:
I understand that the average returns of the stock market are better than mortgage interest rates, over the time span of a typical mortgage term. This is why many of our best and brightest forum members typically argue against paying off your mortgage. Over the long term, you'll usually make more money investing that extra money in the stock market than by applying it towards your mortgage. And the mortgage payoff is an all-or-nothing proposition, because your house can get repossessed when you have 1% left to pay just as easily as when you have 90% left to pay.
Why I'm bucking this trend:
The ACA and the FAFSA, that's why. Now that I'm FIREd and have no W-2 income, my only taxable income is whatever will be generated by Roth IRA rollovers each year. The amount that I roll over is determined by my ongoing expenses, and my primary mortgage is a huge portion of my monthly expenses. If I have to roll over an amount large enough to both fund my family's lifestyle AND pay my annual mortgage bills, the taxable income generated would preclude me from qualifying for health insurance subsides through the ACA or college financial aid for my kids, through the FAFSA. I would appear rich on paper, even though I have no income.
How would this work?
We own a couple of rental properties. With recent valuations soaring in the PNW, we suddenly have more than enough equity in one rental house to pay off our primary mortgage after selling costs. So we could sell the rental this summer, and pocket a huge check. That huge check could sit in our checking account and fund living expenses but it would count against us for FAFSA as a giant asset, ripe for colleges to plunder. If I instead use it to pay off the mortgage on my primary residence, it basically disappears from both the FAFSA and the ACA calculations. Clearing the mortgage would dramatically reduce our monthly expenses, and thus the amount of income we show on paper, qualifying us for cheaper health insurance and financial aid for college. And all we'd have to do is transfer equity from one property (the rental) to another property (our home). And, of course, give up the leverage on both of them.
What does the math look like?
The rental: The rental property currently generates about $5k/year in cash after expenses, and $7k/year in equity pay-down by the renters. The property tax deduction and depreciation are about another $7k together, but are basically worth nothing if we have no taxable income above the newly enlarged standard deduction anyway. We can sell the property and pocket about $200k after costs. It's been appreciating by tens of thousands of dollars per year recently. So I summarize that the property makes us anywhere between $15k and $50k/year, depending on how you count it. A reversal in local real estate could easily wipe out more value in a single season than the property generates as a rental for the year.
Our primary mortgage: We have approximately $200k left on our primary mortage, and pay about $500/month in interest. If we cleared the mortgage, we would lower our expenses by approximately $23k/year, including saving $6k on interest that isn't deductible anymore.
The ACA subsidies: My family of five would qualify for between $5k and $10k per year of ACA subsidy by reducing our annual income by $23k.
The FAFSA: This one is is hard to estimate, but I have two high school aged kids who are potentially eligible for tens of thousands of dollars per year in financial aid if our family income stays below $50k/year so that we qualify for the Simplified Needs Test and they apply to schools that take the FAFSA. I'll ballpark this at cumulatively $20k/year, +/- 100%.
So on the low end, selling the rental means qualifying for about $15k of cumulative benefits while giving up about $15k of income from the rental. On the high end, selling the rental means we might give up $50k of annual rental property income (including appreciation) and receive about $50k of benefits including free insurance and nearly free college. The worst case scenario is if we keep the rental and the local RE market tanks, we could easily lose $40k this year on the rental (including unrealized capital losses) and ALSO give up $50k of insurance and financial aid benefits, for a net loss of $90k. The best case scenario if we keep the rental is that the local RE market continues to appreciate at >10% per year, and we make another $50k on the rental but give up a puny $10k in benefits, for a net gain of $40k.
It's this asymmetric reward profile that leads me towards selling the rental. Rather than risk going $90k in the hole if things go wrong after keeping the rental, I can sell it and pretty much guarantee an approximate wash on lost rental income vs gained ACA and FAFSA benefits. Selling it looks like the conservative play. I don't need to play the RE market and make another $50k in profits next year, that money would mean basically nothing to me because we don't need it. Losing $50k would hurt a whole lot more than gaining another $50k would help, because we're already comfortably FI and don't need more money. We just need to not lose a whole bunch of money, right after retirement.
So as of right now, I'm planning to sell a rental house this summer with the expectation that it will be a wash, financially, to clear my mortgage and thus lower my taxable income. That's totally fine. Keeping the mortgage AND the rental property is probably a better play, financially, if the RE market continues to perform so well, but it comes with the risk of terrible losses and my new financial plan is all about minimizing the chance of terrible losses because that's the only way I can still "fail" at retirement. I don't need to maximize expected gains, I just needed to minimize those early-FIRE sequence of return risks. In this case, I think that means reducing my rental property inventory by one, and paying off my primary mortgage.