… that is the question. Whether ’tis nobler in the mind to be free of debt, or to invest, perchance to dream of outrageous fortune.
If you thought I was going to continue writing in pseudo-Shakespeare, you don’t know me very well. Or maybe you know me too well, because I do love a good writing challenge.
There’s a lot of debate in the personal finance community about whether you should pay off your mortgage early if you can afford to. I’ll share my opinion on that in a little bit. Before I do, I want to make it clear that this is a topic with no definitive answer. Even with my own strong feelings on this one, I can look at the other side and say, “I understand and appreciate your view.”
So if you aren’t going to find any definitive answers, why continue reading? It might help you decide what is best for you and your situation.
Let’s review what each camp has to offer:
Pay Off Your Mortgage Early
There’s a psychological weight to being in debt. While most will agree that mortgage debt (especially at current rates) is good, responsible debt, it is still debt. Until you’ve paid off your mortgage, it’s likely your biggest expense. After you’ve paid off your mortgage, it may be transportation, or food, or property tax. You are a lot closer to financial independence when you eliminate such a big expense like a mortgage.
There’s also a component of certainty. If you have a 5% mortgage, you are getting a guaranteed 5% return on your money by paying off the mortgage early. You can’t get that in a bank account – especially now. You can’t get any kind of guarantee in the stock market which can move in crazy directions from day to day. We’ve seen that happen a lot this year.
Invest the Mortgage Money Instead
Another school of thought is that it’s best to invest any extra money instead. Most people expect the stock market to earn about 7% or more over the long run. That’s a lot better than most of the mortgage rates out there which are probably around 4% (or could be less with refinancing).
Most mortgages are 30 years long – plenty long enough to smooth out the gyrations of day-to-day stock market. Even 15-years (like the other popular fixed mortgage option) is almost always enough time to see stronger returns on stocks.
Almost no one disputes the math of investing in stocks is better than mortgage debt. Even the people in the “pay off your mortgage early” camp typically won’t argue the math. Instead they’ll point to the psychological benefits of alleviating the burden of debt. They’ll also point to the guaranteed X% return noted above.
My Choice: Pay Off Mortgage or Invest?
I strongly prefer mathematical solutions to psychological ones. Sometimes our brains play tricks on us. Math is consistent – it doesn’t play tricks on us.
Let’s say that I have $200,000 left on my mortgage (4%) and somehow lucked into $200,000 (it’s hypothetical, work with me). That mortgage has 25 years left on it. If I pay off the mortgage right away, I’ll save myself from having to pay $533,167 in mortgage payments and interest [Calculation: ((1.04^25)*200000)]. That sounds like a great move. However, if I invest instead, I would have $1,085,486 [Calculation: ((1.07^25)*200000)]. There are some minor things like taxes and inflation to consider, but they are not enough to make up for the fact that investing is mathematically speaking almost twice as good as paying off early.
I’ve heard some people say that they are so happy that they paid off their mortgage – especially now*. With unemployment so high and income so uncertain, being mortgage-free has to be a great stress reducer.
However, we’ve been saving and investing since we bought our house in 2012. We’ve enjoyed a fantastic ride on the stock market. However, even if it was an average ride, we’d have enough saved up that we could choose to be mortgage-free as fast as the banks can make the money move.** Plus we’d have a lot of money left over. That’s what I consider my great stress reducer.
One of the problems I have with paying off your mortgage faster is that the money is gone right away. You don’t have the money under your control any more. If you put all $200,000 into paying off the mortgage, lose your job, and your car breaks down, can you come up with the money to fix it? If you’ve invested the money and still have control of it, you can continue to make mortgage payments, fix your car, and eat if you lose your job. You have the money to buy you time in making all those payments in such a terrible scenario.
As strong as I feel about investing, we went with a middle ground. We got a 15-year mortgage with a lower interesting rate (a very, very nice bonus!). This forces us to pay off the mortgage earlier than most people. This past weekend, a friend of mine said that she’d never be able to pay off her mortgage. (It’s done in 2037, which can feel like never, but probably comes up on us quicker than we think.) In 2012, it seemed like 2027 would be “forever”, but it doesn’t feel like that anymore.
We are also able to save money each month to invest. We saved and invested a lot over the last decade. I feel that a 15 year mortgage is ideal if you have the income.
Final Thoughts on Paying Off Mortgages Early
I was inspired to write this by an article that had nothing to do with mortgages. Miranda Marquit wrote about her Taxable Investment Account/Emergency Fund and I thought, “That’s somewhat similar.”
Most gurus would say that you shouldn’t put your emergency fund in a taxable investment account. Emergency funds should be very safe liquid investments. However, she has a tiered approach with some safe liquid cash and more in invested in equities. It’s worked out very well for her and provides her with a larger emergency fund today than she would have had otherwise:
This tiered approach allows me immediate access to cash while I liquidate investments. It works for me because I end up with a higher rate of return with the money in a taxable investment account. For example, I’ve got a 13.3% cumulative time-weighted return with the taxable investment account, since the beginning of 2010, when my return with my savings account has been 3.6%.
Marquit has some safety, but also a lot of growth. This seems similar to investing with extra money instead of paying off your mortgage early. I feel I get that safety of control over the money, while growing my nest egg for more safety (or enjoyment) down the line.
What do you think? Let me know in the comments below.
* Is that the 4th or 5th time I made use of “especially now”?
** Most of our investments are in retirement accounts, so we would get a penalty if we cashed out to pay off our mortgage. However, we could do a partial cash out of a little of our investment profits to buy us a year or two of mortgage payments.
We love the 3% rate we have on the 15 year mortgage on what has been our primary residence in NYC! And 5 years in already, the end doesn’t seem too far away!
In your scenario, of coming into the money with 25 years to go in the mortgage, I’d probably invest a lot of that elsewhere, but then also use some of it to apply a bit extra to the mortgage payment each month. Depending on how much extra you pay each month, it can have a dramatic effect in both lowering the total interest you will pay, and reducing the number of total months to pay off the loan.
That 3% is great! We have a 2.75% from 2012. I find it hard to pay that off early, but maybe if we did come into that money, we’d feel differently.
I think either is great. Investing or paying off the mortgage early will make life better for anyone.
The SALT cap makes a difference psychologically too. Previously, it feels better to have a mortgage so you can get a deduction.
I stuck with the 30 year mortgage for our home. I don’t plan to stay here forever so I don’t really need to own it 100%.
Yep, losing the SALT cap hurts a bit. We were lucky that we had front-loaded a lot of our interest payments before the tax change.
This topic has been weighing heavily on my mind in the last couple of years. My situation is much different than your, I’m 56, the primary income source, and my wife was out of the workforce(though she is a medical professional) almost the entire time our children were home. I had refinanced our house to make the cash flow work while the kids were in private school. I technically have 19 years left on the 30 year mortgage, though I’ve been prepaying and would have about 14 years if I dropped back to the regular payment and just over 7 if I keep on the current increased payment.
We’ve hit a goal level in our retirement plans so I have run numerous simulations for what it would take to pay off the mortgage more quickly(3 -5 years) though I’m not sure I’m comfortable with what that would take. The pay off vs. invest has been debated since the beginning of time, though the invest side isn’t pure math since it requires assumptions about investment returns. Over the next few years(5-7 for me) it is going to be really hard to predict those returns.
If you are looking at 5-7 timeline to hit a goal, such as retirement, I can see the desire to pay off a mortgage early, especially if other investments are doing well.
The investment side isn’t math, because assumptions do have to be made, but most people make those assumptions in their investment decisions anyway. For example, many people plan a return of 6-8% on stocks in their retirement plans. They don’t plan on earning 0% for 15 years in a retirement plan, so I don’t think it would make sense to plan for it when comparing investing vs. paying off a mortgage.
For this reason, I don’t put any weight in fearing those assumptions.
The next few years will be interesting to see given that we are in times that I haven’t seen. 20% unemployment, national debt growing at record levels, civil unrest, etc., and stock market prices that aren’t tied to anything concrete.
One thing I forgot to mention, you do hear people say they want to pay their house off so it can never be taken from them. While property values in much of Texas are comparatively low, the property taxes are high(to offset not having a state income tax).
With interest rates as low as they are – it is really hard not to just keep the mortgage and invest in the markets. However with the markets likely to turn soon, the change in the tax deductions on taxes, both of those changes the situation.
To me, you borrow money because you don’t have enough liquid cash to cover the overall expense of a house. You are prioritizing many things in your savings plans (retirement, kids college, etc.) vs just a single item (your house).
I have a fun scenario at the moment. I own a house, no mortgage. I moved (2400 miles away) and have someone doing a rent to own (owner financing). Their rent is going toward eating away at my equity in the house. I am looking to buy in my new state, but the whole COVID thing and I have no cash for a down payment. I have $250k in equity in my old house but have to wait for the person who is buying it to get a mortgage to access that as a down payment on my new home. I can cash out of the stock market in my taxable account but that is no fun come tax time. We shall see. I don’t like renting, as if I am spending $1500 a month on a place, I would like to be starting to get ownership of it.
Big-D,
That is an interesting situation. I hope it’s just a temporary one. Maybe you can work out a rent-to-own situation on a place that you are looking to buy so that you are getting ownership of it.
I’m intrigued about how this would work. I have a property that I wouldn’t mind selling off to my renter if the numbers worked out. I don’t completely own it though, and it would be a messy arrangement with the current mortgage.
I paid my 360 month mortgage off in 97 months. While doing that I maxed out my 401k, Roth IRA and kept 10k in cash on hand. When I had about 200k in equity I opened. 100k HELOC, at prime rate, so I had quick. easy, cheap access to cash.
The extra $600 a month in principal would of returned less than 80k in the market, assuming 7% return. I saved 45k in interest.
35k difference.
Worth it to me.
That’s some payoff to get a 30-year mortgage done in 8 years – especially while maxing out retirement plans.
Maybe after taxes, it would have been less than 80k in the market and the interest you saved could have made it close to breakeven.
We’re essentially paying an $600 a month by choosing a 15-year mortgage instead of a 30-year mortgage. So it’s similar, but not as aggressive.
The main comment I have would be what is the difference if you were to pay the mortgage off but then for the balance of the mortgage invest every penny of what would have been your mortgage payment? I agree there is going to be a difference but I think the math makes the differences in the choice much smaller.
Actually, I just did some math and very crudely using a 4% mortgage for 15 years as a sample point the difference between the two is ~40K. I could be off a little on the actual calculations but the reality is that if you are going to take every penny and invest it it’s close to a wash. It comes down to preference
I could see it being close to a wash if you invest afterward. It’s hard to do the real math because it depends how quick you pay off the mortgage and what the rate is.
Perhaps I feel more strongly about this because our mortgage is at 2.75% and the market returns over the last ten years is 12% (source: DQYDJ). So if you spend 15 years paying down at ~3% and 15 years investing 12%, your average is roughly 9%. It’s better to take the 12% the whole time. Of course, that 12% is not typical.
Here’s a bit of a wild card – home equity is not considered to be an asset on the FAFSA for financial aid. (Note that some colleges use the CSS profile, which does consider home equity.) So paying down your mortgage (and thus increasing your home equity) could help your financial aid situation.
This won’t necessarily be true in the future. I wouldn’t be surprised if FAFSA started including it.
That’s true. However, you can use the investment money to pay down the mortgage to hide that home equity when you cross that bridge (applying for the FAFSA).
Also if the investments are in retirement accounts (which can make it hard to pay off the mortgage) they won’t count towards the FAFSA.
FAFSA is a mess and there are lots of ways to get around it. My son got full ride to a state school, even though I had custody, made over $100k a year, and have no other children. You would think I cheated, but had 3 different financial aid offices tell me I filled the forms out right.
Wow. I went to a state school (93-97), my parents made 10-15K/yr, and I came out with tons of loans.