There is a ton of ink written on this subject. Paying the house off early is one of the more divisive topics in financial planning. Before I go into why I am choosing to pay off my house early, I will explain the argument for taking out a 30 year mortgage and never paying an extra dime, keep in mind, there is no one size fits all solution here. The thesis of the argument to keep the mortgage is this: If I am expecting 8 to 12% returns in stock market mutual funds long term, and my mortgage is 3 -5%, I net 3% to 7%, by investing the money instead of paying down the mortgage. The home mortgage interest deduction also reduces the price of the interest by providing a tax deduction, so it’s really like paying only 2-3% in interest (for certain individuals), I certainly can make more than that in the market. Johnny Moneyseed wrote an excellent article showing the numbers involved. Here’s why I am paying mine off early: (In order of importance)
1. I do not view my home as an investment. My wife and I plan to stay here for the rest of our lives. I view the house as the roof over our heads, it is an expense, and one of the most basic expenses. I do not like the concept that if I came upon hard times a bank could take our house from us, or that I would have to sell investments at an inopportune time to stave off a foreclosure. The intangible “peace of mind” is worth the probable investment return opportunity cost to me. When my wife was younger, her family lost their home, and I don’t want the thought of that happening again to enter her mind. Is this all irrational? As a man who loves his spreadsheets and running the numbers, a resounding YES!!! We make decent money, bought a house half the amount the bank was willing to lend us, have no other debt, and 6 months of expenses in cash. It would be HIGHLY improbable that we would end up not being able to pay the payments to the bank. But that’s okay, in this arena of life I am willing to be “impractical”.
2. Our income is not high enough, nor is our house expensive enough to warrant itemized deductions. This takes away the argument for the tax break. You only get as much of a deduction as your itemized deductions are in excess of the standard deduction, and this only helps to the extent that you are in higher tax brackets. Since we don’t have enough itemized deductions to be more than the standard deduction, this tax incentive does not exist for us. I also am against the existence of the mortgage interest tax deduction.
3. We are investing enough into stock funds to ensure an early financial independence already. I am by no means advocating paying off the house before investing for retirement. These are two separate goals. We are saving at a high rate (20%+) into stock mutual funds in tax advantaged accounts FIRST. The rest of our savings will go towards mortgage principal prepayment. This can be seen as the “conservative” side of our investments. We invest our paper portfolios very aggressively, and paying off a mortgage early is very conservative. I believe this gives us a bit of balance.
4. The house short and long term, is a relatively small portion of our lifetime income and wealth. Currently our P+I is roughly 10% of our income, and the current value of the house is under 2X our annual income, so while the math says I could possibly make more money in stocks, The potential loss for the trade-off isn’t a super large amount. This helps make the decision, especially when the math says its not the best move. Also, because the house isn’t super expensive the time line for paying it off is shorter, which also makes the math easier to accept. In the argument over paying the house off early, both sides can attack the other by taking the argument to extremes: “Since you aren’t paying off the mortgage early, in order to invest in stocks, then why don’t you take out a HELOC as much as the bank will allow and buy more stocks with it? Why not try for a 40 year mortgage?” The rationale of course is that if this were done someone could run into the danger of owing more on the house than what it is worth. While the math is still the same, the risk is greatly increased if more is borrowed than the home is worth. On the other side, an attack on the pay it off early crowd is “If debt is so bad, why get a mortgage on a house to begin with, you should have just paid cash.” The rationale behind this is that debt can be a useful tool, but you want to minimize how long you have it and how much you pay. While it is extremely difficult to pay for a house at once, it is less difficult to make larger payments on a 10 year, 15 year, or 20 year mortgage schedule. This method reduces total time in debt and total interest paid, while still giving the benefit of not having to come up with the total cost all at once. No one is “right” in this argument, what matters is what is right for you. For some people it makes sense to not pay a dime extra on their mortgages, while for others it makes sense to pay them off more quickly, it all depends on your life situations. Who would most likely benefit from paying off their mortgage quickly:
- Those who view their house not as an investment, but as the essential shelter for their families, and who do not plan to move
- Those who do not receive a tax deduction on mortgage interest
- Those who have relatively high interest rates
- Those who are already saving over 15% for retirement in stock mutual funds
Who would most likely benefit from keeping a 30 year mortgage on their primary residence and investing the difference: (For the purpose of this paragraph, “high earners” are those in the 25% bracket or above.)
- High earners who already itemize deductions
- High earners who also have large mortgages, thus receiving a higher deduction
- High earners who have NOT already maxed tax deferred savings vehicles (401k, IRA, HSA)
- People who plan on moving in the not too distant future
- Those locked into super low rates (The definition of “super low” will vary over time)
My overall goal is to have the house paid off in 8 years. At this point in time our oldest son will be graduating from high school and we will be in a good position to assist with paying for college out of cash-flow. So what do you think? Does paying off the mortgage early make sense to you, or is it a crazy move in your world?
Update: 12/31/2015; I just paid an extra $5,000 on my mortgage and it feels great!