Is it wise to pay off your mortgage early? The debate about when to pay off a mortgage seems to be a popular one in the financial world. Some prevailing financial personalities abhor debt and suggest paying it off at all cost. Others (including many finance professors & rich dad) seem to enjoy low-rate mortgages, and fundamentally love the idea of a leveraged debt position. I’m not really sure there is a right or wrong answer in the debate, but I know we have chosen a side and I’m pretty happy with where we currently sit.
About three years ago we found a little house we liked in a great southern town. We saved pretty aggressively after we got married so we had a good down payment to go with a small mortgage. We fixed up the little house and it has been a great place to live as our family has begun to multiply. Although we chose a traditional 15 year mortgage, we realized if we put a little extra towards the house we could pay it off pretty quickly. Once the idea was planted, we focused, and ended up paying it off much faster than our initial estimates. So, why did we pay off the house? Why not invest the money in the market instead? Is it ever smart to pay off low-interest debt?
The Mental Debate
I’ve been interested in personal finance and financial independence for many years now and I’m always on the lookout for different strategies to move closer to the goal of financial freedom. I’m a big fan of attacking financial freedom from both ends by earning more and being a conscientious spender. I also like the idea of having a big fat pile of money and very few expenses. I also am driven by financial simplicity. I like the cleanliness of having no outstanding debt obligations. It is relaxing to me. The mental debate continued in my head so I had to list out some of our personal pros and cons of paying off our house early. Here is the mental pro and con list that helped us make our decision:
- Increases cash flow
- Provides flexibility (from cash flow standpoint)
- Reduces stress
- Provides a guaranteed (internal) return on investment
- Simplifies our financial planning
- Saves money on interest paid
- Increased freedom
- Impresses* Dave Ramsey
- Prove it can be done
- Forced savings with short-term feedback
- Easily measurable progress with a fixed goal
- Decreases liquidity
- Increases diversification risk (depending on net worth)
- Giving up other fun things to pay it off faster
- Potential tax consequences (although mostly overrated)
- Opportunity cost of not being able to invest the principal
Most economists argue over the minutiae of opportunity cost. Sure, you do potentially give up a little interest for margin training, but paying off your house early doesn’t necessarily prevent you from dumping tons of money into the market or other investments. We like the idea of investing 50%+ of our income and having a paid for house. It does come at the expense of consumption but, for me, the tradeoff is worth it. The end goal is to have a paid off house and money! If you have little to no expenses and lots of money you have freedom. Little Money, few expenses – one type of freedom. Large Income, high expenses – different kind of freedom. No expenses, large income – the best type of financial freedom!
So, for us, the pros outweighed the cons to the point where we decided to just go for it and prioritize paying off the house. We continued to invest during the process, but it is nice to not worry about having a house payment. If we ever wanted to travel the world, sell our house, or pursue other opportunities, we do not have to worry about a large payment hanging over our heads. There is an unexplainable relaxation that comes from the lack of worry that may be difficult for people to see who have normalized a leveraged lifestyle. It relaxes me to minimize our family’s outflow.
Being A Financial Example
When you get a PhD in financial planning and spend your relaxing time writing additional articles about personal finance, you gain the local reputation among your family and peers as a financial example. In the same way that a pastor’s personal life is examined, the personal financial lives of people in the financial planning world are also examined. *One really nice part about paying off your house early is the fact that everyone can relate. Housing cost is a relative expense. There is a strong correlation between income and what you pay for housing. Typically, housing costs are around 20-40% of the average American’s income. The reason why this is important is that it is a metric that can be compared across all demographics and income levels. There is an innate understanding of the cost and positive implications of having a house paid off. 500k in investments means nothing to a 10x millionaire and is unrealistic for someone making a $10 a day. However, everyone can relate to not having to pay any rent or housing costs. It translates easily.
Why This Won’t Work For You
The inevitable response you will get when you let people know you are planning to pay of your house early will be: How? The idea of forgoing current consumption to benefit your future self is not very popular. Americans want to spend everything they make. Even when incomes rise, we like to spend it all. People simply want to consume everything they earn. In addition, almost everyone you know has designed their life to be expensive. So, the first step is planning ahead to spend significantly less than you make. Typical Americans average somewhere between a -1% to 4% saving’s rate, but I would expect Simple Economist readers to start the benchmark at 50% and go from there. The earlier you start the easier it will be. Once consumption starts, you soon realize that luxury is an expensive drug.
Going Against The Grain
Most Certified Financial Planners, banks, stock pickers, and investment advisers make money when people invest money into their products or services. Secondly, the more money you spend, the more money they make. Most advertising and media are also commanded by these individuals and companies. Not surprisingly, most of the leading sources for financial information inherently produce the same message: Invest more with us. Leverage more. Borrow money at low rates and invest it with us. The strategy is not all bad, but be aware that most of the marketing information about debt comes from people benefiting from it rather than from consumer advocates.
A Bad Economy
At some point the economy will go through another recession. I think the main argument people have against paying off a house early come from the margin between current interest rates and what could be made in the market. The idea being that you could use the money/equity in your home to invest. This methodology often fails to accurately consider the risk involved inherently in borrowing money. Having a paid for house significantly lowers your income needs and your short-term risk position. In a deep recession, housing prices fall, stock markets tumble, and jobs are lost. When you add highly leveraged assets to the equation and low stock prices you run the risk of having the perfect storm of financial failure. Basically, paying off your house is a low return but risk minimizing strategy. And, if you are efficient with your spending, the process should only take a few years to complete.
The Relaxation Factor
How would you feel today if you had no payments at all: No credit card, car, house, or college payments? That is a pretty relaxing feeling for most people. In fact, I know many people who felt the pain of a highly leveraged lifestyle when things were not looking too good in 2009. I like the idea of getting rid of debt and investing a lot of money. The flexibility of a structurally low cost lifestyle combined with plenty of money in the bank is a great place to be. So, we paid off the house. It is a pretty good feeling. I’m looking forward to the next 70 years of my life without having to pay rent or payments to a lending institution. And, best of all, I sleep pretty well at night.