I’m frequently asked about paying off a home mortgage. I tell everyone, “It depends!”.
I asked that same question. A friend said his CPA was emphatic that one should not pay off their mortgage. He arranged a meeting where the three of us could talk.
The CPA asked about the interest rate; 6% at the time. He showed me excellent stock market returns, suggesting I could earn more than 6% and continue deducting interest on my tax return. Other People’s Money (OPM) was the buzzword at the time. The smart people used borrowed money to become wealthy.
I was self-employed and worried if I had a bad month. Wouldn’t not having a house payment be a good thing? He said, “NO! Financially it’s not a smart move.”
“Is your home paid for?”, I asked. His response, “Oh Hell Yes!” I was shocked. He explained his wife was from Europe. They don’t believe in debt – she made me pay it off. I asked, “Do you sleep better at night not having to worry about a house payment?” With a sheepish grin, he replied, “Yeah, I do.”
I realized the decision is both emotional and financial and the right decision is different for everyone. I upped my house payment and in a few short years, it was paid off. I never looked back!
Please don’t jump to any conclusions – there are other factors to consider.
What’s the real goal?
| The goal is to eliminate ALL DEBT and accumulate wealth; particularly retirement funds. Paying off a home mortgage is one step in the process. |
Not everyone agrees.
In the MarketWatch article, “Should you pay off your mortgage or invest the money?” they outline 5 reasons to keep your mortgage.
- Homeowners need to maintain liquidity.
- A mortgage doesn’t affect a home’s value.
- Mortgage interest is inexpensive.
- Mortgage payments get easier with time.
- Investments will outperform the interest cost of the mortgage over the long term.
Let’s dissect the premise using (fictitious) Bob & Mary Jones. Their combined income is $80,000. They have a $200,000, 30-year conventional mortgage at an interest rate of 4.5%. Bankrate.com provides a handy Amortization Schedule Calculator. Their monthly payment would be $1,013.37.
Money Under 30 provides a tool, “How Much House Can You Afford?” They tell us:
“…. The golden rule in determining how much home you can afford is that your monthly mortgage payment should not exceed 28 percent of your gross monthly income. For example, if you and your spouse have a combined annual income of $80,000, your (monthly) mortgage payment should not exceed $1,866.”
Bob & Mary are well within the guidelines.
Homeowners need to maintain liquidity. You need enough liquid assets on hand to cover an unexpected emergency or job loss.
If they felt comfortable with a six-months income available ($40,000) they have several options. Pay down (but not pay off) the mortgage and hold back their savings. By doing that, a larger percentage of their house payment goes toward principal, providing significant interest savings.
I’ve seen cases where homeowners have a “signature line of credit,” using their home as collateral. If they have an emergency, the bank will put the money in their checking account. They don’t pay interest unless there is a real emergency and they have to borrow.
A mortgage doesn’t affect a home’s value. We are concerned about increasing the net worth of the homeowner. Interest is renting other people’s money. The less you pay in rent, the more you can save and build your own net worth.
Mortgage interest is inexpensive. While interest rates may be historically low, how much money you have to pay in interest is the major issue.
The Amortization Calculator tells us Bob & Mary will pay $164,813 in interest over the life of the loan. Interest adds 82% to the cost of their home.
Nerdwallet suggests you should keep your mortgage:
“If you financed – or refinanced – in the past five years or so, you have a low mortgage rate. In other words, you borrowed historically cheap money.”
Hang on a minute here! Bankrate.com also provides a Mortgage Payoff Calculator. Each year, Bob & Mary pay $12,156. In the first year, 73% of their monthly payment went to interest. The early years of a mortgage are when you pay the most interest.
Amortization Schedule
| Payment Date | Payment | Principal | Interest | Total Interest | Balance |
| Jan 2018 | $1,013.37 | $263.37 | $750.00 | $750.00 | $199,736.63 |
| Feb 2018 | $1,013.37 | $264.36 | $749.01 | $1,499.01 | $199,472.27 |
| Mar 2018 | $1,013.37 | $265.35 | $748.02 | $2,247.03 | $199,206.92 |
| Apr 2018 | $1,013.37 | $266.34 | $747.03 | $2,994.06 | $198,940.58 |
| May 2018 | $1,013.37 | $267.34 | $746.03 | $3,740.09 | $198,673.23 |
| Jun 2018 | $1,013.37 | $268.35 | $745.02 | $4,485.11 | $198,404.89 |
| Jul 2018 | $1,013.37 | $269.35 | $744.02 | $5,229.13 | $198,135.54 |
| Aug 2018 | $1,013.37 | $270.36 | $743.01 | $5,972.14 | $197,865.17 |
| Sep 2018 | $1,013.37 | $271.38 | $741.99 | $6,714.13 | $197,593.80 |
| Oct 2018 | $1,013.37 | $272.39 | $740.98 | $7,455.11 | $197,321.40 |
| Nov 2018 | $1,013.37 | $273.42 | $739.96 | $8,195.06 | $197,047.99 |
| Dec 2018 | $1,013.37 | $274.44 | $738.93 | $8,933.99 | $196,773.55 |
It will take over 15 years (August 2032) before ½ of their monthly payment is applied to the principal.
Mortgage payments get easier with time. That is true, unless you are getting close to retirement and realize you need to accelerate your retirement savings.
| What could be easier than having NO mortgage payment and not having to worry about it? |
In today’s world of job insecurity, few pundits ask, “What happens if you lose your job?” Not having a mortgage payment can make the new job search much less stressful.
Investments will outperform the interest cost of the mortgage over the long term. It may be true if you are a top-notch investor and have plenty of time to spend studying and staying on top of things.
If mortgage interest rates are low, safe, high quality fixed income investments pay even less. Can you guarantee you will not lose money?
I have friends in their early 60’s who chose not to pay off their mortgage and saw their nest egg cut in half during the last downturn. They were trying to squeeze every last dollar out of the market and got caught. Some are still working.
There is one exception. If you are self-employed you may need to borrow and invest in your own business. The risk is much better understood.
A common sense approach
Assuming the goal is to be debt-free, and accumulate wealth, start with the big picture.
List all your debts, monthly payments and interest rates. How much do you owe? How much cash (excluding retirement accounts) do you have available?
How much do you need to maintain liquidity? While you may be able to pay down your mortgage, don’t create another problem. Make sure you have ample “reserve emergency funds” available.
What to pay off first? Conventional wisdom is to first pay off the high interest loans and credit cards, or those with the most burdensome monthly payments.
Know thyself! If you fear having an impulse to “go out and buy something else,” be realistic. You might be better paying your mortgage down to temper your impulse buying.
Pay ahead of schedule. Bob & Mary might choose to use $50,000 to pay down their mortgage. That cuts their mortgage by approximately 12 years. While the payment remains the same, a much higher percentage is applied to principal.
Bob & Mary could cut five years off their loan in a couple of ways. They could increase their payment $100/month.
-or-
Bankrate.com offers a Biweekly mortgage calculator. Paying ½ every two weeks saves on interest and adds one additional payment annually.
Misinformation
Don’t get fooled by the malarkey that you should have a mortgage because the interest is deductible – chances are you won’t use it. The Tax Foundation tells us in 2013, 30% of taxpayers itemized their deductions, generally high wage earners.
Forbes outlines a White House study about the recently passed tax reform bill, “Nine In Ten Will Claim The Standard Deduction.”
When it happens….
The benefits of owning your own home are both financial and emotional. It’s hard to explain the exhilaration of paying off your home and committing to never borrow money again.
| I have NEVER met anyone who paid off their mortgage that regretted it. |
Paying off your mortgage is a great feeling; however, it is part of a bigger picture – being debt free! That is where true wealth accumulation begins.
The Big Kahuna
Once you are out of debt, you are not “home free” (pun intended). What do you do with the money left over each month? While it may be fun, paying cash for expensive, depreciating assets is not accumulating wealth. Focus on a higher priority first.
The most basic human need is survival. Next is security – “survival for tomorrow”. When you can no longer work, how are you going to survive? Accumulated wealth allows you to meet those needs with minimal worry.
Maximize your contributions to your 401k, IRA and any other retirement plans you may have. Then you can realistically calculate how much “fun money” you really have. You will still have fun along the way, knowing your plan is working.
Do I recommend paying off your mortgage? Absolutely! The Baby Boomer generation, in particular, is at the point where capital preservation, not taking high risks hoping for a good return, take precedence.
If you can’t pay off your mortgage today or in the near future that’s OK. Take stock of things and build a plan to get out of debt; you will be there before you know it! You will never regret paying off debts!
And Finally…
“If you always protect your offspring in a cocoon they will never learn how to fly…”
For more information, check out my website or follow me on FaceBook.
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10 Easy Steps To The Ultimate Worry-Free Retirement Plan
Until next time…
Dennis
www.MillerOnTheMoney.com
Pay it off. You are provided a risk free return … the saved interest expense. You are free to engage in other speculations and have a place to sleep out of the rain, no matter what. You can make other lifestyle choices that are unavailable if you are tied to a mortgage. It feels great.
Precisely… or you could go all in and buy NSAcoin on a credit card!
Or you could live in your van and put all your money into bitcoin
Hi Martin,
Make sure your van is paid off!
Best regards,
Dennis
Martin’s comment made me laugh.
Anon’s comment made me laugh a lot harder.
If you lose your job ( or your wife does) you may need to relocate. If you own the home you do not need to sell it in a down market or have it sit vacant for months eating up your cash. You can rent it out and do not have to ‘cover’ anything beyond insurance, taxes and maintenance.
The only time I ever got a ‘deal’ on debt was when Toyota offered me 48 months zero percent financing while Wachovia Bank was offering me 5.25% on a 48 month $25,000 CD.
Haven’t had a mortgage since 1989. Best move I ever made. Allowed me to retire early and ability to live on less income.
Pay it off! Spend a few years selling crap you don’t use, then put that plus all raises, bonuses, tax “refunds” and every spare penny toward debt. Cut back on everything and put the savings towards debt as well. Watch it melt away.
When you’re done you’ll find that the discipline of doing without remains and the extra money formally used to service debt piles up rather quickly. It’s a great feeling!
+10 Dentures! I’m w ya.
Once you have the mortgage, then all of the above calculations apply. When you’re getting a mortgage, you have the choice of (among other things) a 15 year fixed rate versus a 20 or 30 year fixed rate. A 15 year loan is usually about 3/4% lower rate than a 30 year loan. In other words, you pay a big premium in rate for the privilege of making a smaller payment on a 30 year loan. If your plan is to “invest the difference”, you’d need to make a huge (implausible) investment return to offset the drag of paying a higher mortgage rate. Take the 15 year if you can reasonably afford it. I realize this has no bearing on Shit Throwing Monkeys – most of whom are looking for a good deal on walkers and burial plots. 😉
And Viagra.
Speak for yourself. Mine still works just fine. 🙂
Case history:
Last rent payment before home ownership was $200 for a basement room. (’92). Had just bought a new Saturn w financing. I needed reliable wheels for work.
Finally had enough squirreled away for 3k down, 3k to cover closing costs on a house for 62,500. Took out a 30 year mortgage. At 7-3/8% rate, Principal, interest, & insurance made a monthly payment of around $560 / month. Oh, shit. WTF did I get myself into? It worked out ok, as it forced better financial discipline for sure. Then looking at the amortization schedule, and one sees that over 30 years, a payment where the interest gets the bulk of the payments on the front end was one shock. The other was seeing that 59,500 borrowed would require 96k of cash outlay payments in total over 30 years. Or something like that number. Screw that. Fortunately started earning decent coin, and consistently started paying $200 extra toward the principle loan amount. In 2002, rates lowered, and I refinanced to a 15 year note at 5.25%. House was appraised at 120k at that time. Still aggressively paid extra 2 Hundy against the principle each month. Paid off in 2013, in effect w a 20 year mortgage. See I.S. comment above, for the benefits of free & clear. Pay it off ASAP. Even through the housing bust of 2008, I wouldn’t use home equity for cars, a boat, or other toys. Minor upgrades over the 20 years of payments, but now the extra cash is being used for more extensive remods and updates that should bring good ROI. Here too, very little borrowed for the new kitchen. Ditto for an added 1/2 bath. Next up, a new full bath remodel.
It wasn’t how the crowd did it. I saw that mortgage debt as slavery. Only drawback is, now materials & labor cost more, the result of inflation. But all things considered, I’d do it the same way, only take a 15 yr. loan out for the purchase, and put a larger down payment into the mix, if at all possible.
post script: forgive any mis spelling on which form of the word principle / principal.
No access to Webster’s at the moment.
-suds
Having a mortgage payment because “interest is inexpensive”
is akin to “watchful waiting” with a cancer diagnosis. The sooner debt cancer is eliminated, the healthier you will be. We saved over $50,000 in interest payments to the banking cabal…can sleep at night knowing equity is now available for retirement…consider owning your home as part of diversification of assets…
Hi,
Great analogy about watchful waiting.
Semper Fi!
Dennis
Actually, you should not only pay off the mortgage, but stay out of debt completely.
Disclaimer: I hate bankers.
Agree!! Don’t feed the monkeys at the bank! Own everything outright and live within your means.
I have for 20 years. Cash for cars. Put anything I can on my one CC and then pay it completely each month. I even time big purchases to happen at the beginning of a billing cycle because that gives me almost two months before that money is due to be deducted from my checking account. I’ve even put $5K down payments on my card for car purchases. Plus I get 1% back.
A perhaps better option for those with the ability to discipline themselves and control their spending is to rent. Rent usually has a lower monthly payment. Invest the difference. That is probably the better way to accumulate capital. But it means no private home.
If something does not generate income, it is not an investment. Private homes do not generate income. Hence, they are not investments. Private homes may eventually generate capital returns, but in the meantime they chew up lots of capital – taxes, insurances, upkeep, utilities, etc.
They do however force people to save that are not otherwise disciplined.
That’s a great point. When I move or downsize to renting, I’ve thought it better to rent out the crib I’m free and clear with, knowing it’s history. Yes, grabbing a foreclosure in 2009, at market bottom, rehabbing it, and renting it out for the income stream was a missed opportunity.
I don’t always agree w you Llpoh, but I pay attention to successful people’s experience & advice. Thx.
-suds
One of the biggest reasons I bought was because it was MORE expensive to rent. Before I moved a couple years ago, I was paying about 20% more to rent a place than I could have bought the same floor plan in the same neighborhood. Sure, that doesn’t include upkeep, etc, and the other risks of potentially being stuck with it.
I doubt I’ll live here long enough to pay my current house off, but I pay enough extra towards the principle every month that it amounts to an extra payment and a half each year. Ill be getting a pay raise later this year, 20% of which will be added to my extra principle. Even if I don’t live here long enough to pay the house off completely, Ill have more equity when I go to sell. If you ever want to be able to retire, and I do one day, not having a mortgage is a pretty important component.
You’re correct about the home (the structure) being a consumption item rather than an investment, but the property upon which the home stands can be put to use so that income is produced while keeping the income-producing assets close to home, no?
Property taxes in the town 10 minutes from work are $10,000 a year. I found a rental for $880 a month. Already bought my GTFO house in the mountains for cash 20 yrs ago; $200 a year property taxes. Saving up for another cash purchase to be done this year.
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Robert (QSLV)
“Do I recommend paying off your mortgage? Absolutely!” 100 thumbs up, Dennis. That’s the best advice you could ever give anybody
No mortgage means not needing to worry about losing your home when the company you work for is laying people off in droves, or the owner of the small company your spouse works for passes away unexpectedly. It also means you can sell your house on your terms. If you’re disciplined you can also continue to save and invest your mortgage payments for your own use, instead of paying that money to the bank.
You can’t write off mortgage interest in Canada, and other than Alberta , you can’t leave the keys on the kitchen table and walk away from your mortgage up here if your financial situation takes a negative turn. If you choose to buy (and there’s ample math to show you’re better off renting and investing if you live in Vancouver or the Toronto area), you need to pay off your mortgage as soon as you can.
Inflation at 10% per annum and your mortgage is 3.85% (mine). I’m in no hurry to pay it off. Paying back in cheaper dollars suits me jus’ fine. Borrow dollars and pay back in pennies…
Buy less house than you can afford, get a 15 yr mortgage, pay it off early as possible. Purchase pre-owned cars that have a reputation for reliability. Pay off credit cards, then keep one if you travel. I did not do this at first, but went to the school of hard knocks. Completely agree with the author.
You may pay off the mortgage, but property taxes will always be there and always increase over time.
See what happens if you fail to pay the ridiculous annual skool and county property taxes.
I set aside $900.00 a month to cover these without any mortgage. I essentially rent from the skool district.
Glad I don’t live in Jersey, It would probably be triple this amount.