Do you intend to aggressively pay off your mortgage? Financially, is that a smart thing to do? Initially, I believed it was the right thing to do. Or at least, that's what I've been told and that's what I was reading in numerous FIRE related articles and books. But, is paying off your mortgage to become "debt free" the best way to build wealth and become financially independent?
I was aggressively making extra mortgage payments for over a year. I heard about the benefits:
- You'll save tens of thousands of dollars in interest payments over the term of the mortgage loan (15, 20, 30 years)
- You'll need less money in your emergency fund without a mortgage payment
- You'll feel better psychologically knowing you are debt free (assuming you paid off all other debt) and you'll reduce your stress level
- It is emotionally gratifying to "own" a home that can't be taken away from you
Then, I stumbled on financial articles that suggested it wasn't necessarily the best way to become financially independent and build wealth. The evidence was compelling. I started to have doubts that it made "financial" sense to pay off the mortgage. I realized I really didn't know based on "the numbers" for our specific situation. My wife and I have a low interest rate on our mortgage (below 3.5%).
On a side note, you can be debt free and NOT financially independent. Just because you don't have any debt doesn't mean you can quit your job, travel the world, and do whatever you want. Being financially independent does.
Understand the difference and focus on Financial Independence the Dream Oasis (FIDO). Focus on building wealth. Focus on recurring revenue and making your money work hard so you don't need to work at all. Maintain a positive net worth that grows automatically. Understand that having more than enough money on hand to pay off your mortgage debt is just, if not more, emotionally satisfying then paying it off.
How Do You View Money?
Change your "mindset" with respect to how you view money. Be a money manager. Managers make more money than those they manage. Don't let your money manage YOU! Don't drink the Kool Aid and believe being debt free is the goal and salvation. It's not; true financial independence is. Living your dream is.
I decided to educate myself on the mortgage subject and do the math. Here's what I learned and why I'm no longer paying off our mortgage early. It just doesn't make "financial" sense for us. It may for you, but I doubt it with today's historically low mortgage rates. Ask yourself some questions. Do what builds your net worth the fastest because that's how you truly become financial independent. It's not just about being debt free; sorry Dave Ramsey, Suzy Orman, and Mr. Money Mustache.
Orman recommends that you aim to be mortgage-free by the time you retire. That's because everything you owe, including your home, costs you money, but it can affect your mental health as well. "Debt is bondage," she says. "You will never, ever, ever have financial freedom if you have debt." (CNBC article, Suze Orman: This is when to pay off your mortgage)
Orman's statement above is just not true. Many of the wealthiest people in the world carry debt. In fact, they leverage their debt to make more money. They buy businesses. They buy real estate, art, antique cars, and so on. They take educated risks and their assets appreciate more than the cost of their debt.
Focusing on paying off your mortgage and not investing early can be a bad idea. Sorry Dave Ramsey fans but paying off your mortgage isn't necessarily the best way for everyone to build wealth over time. I have no bones to pick with Dave Ramsey. He is providing a lot of great advice. However, let's do the math or call Dave Ramsey and ask him to do the math for you. I haven't seen him provide financial proof on this topic, but it may be somewhere I haven't looked?
Pay Off Mortgage or Invest - Questions to Answer For Your Unique Situation
- Interest Rates: is your mortgage interest rate low or below 5%? Historically, a mortgage interest rate below 5% is a gift! It is likely the cheapest money you'll ever see in your lifetime. Wealthy folks understand how to leverage access to cheap money (OPM - other people's money) to make money, that's a fact.
- Will your home increase in value? Your home will likely increase in value over time with or without a mortgage. However, it will also likely decrease in value at some point given real estate is cyclical, historically. Your net worth will increase when the value of your real estate increases. If it decreases, you lose more if your mortgage is paid off. You are better off having the funds in a money market or online savings account gaining 2% in interest or whatever return you can get from a conservative investment.
- Retirement Accounts: Are you maximizing your retirement account contributions? Are you reducing your tax liability by doing so? If you are self-employed, you can save thousands in taxes by opening up a SEP or Solo 401(k). The return received by doing so can increase your net worth above and beyond the cost of your mortgage debt. If you are not self-employed, you can open a business, or buy a business. Then, you can open a SEP, etc. You have more options when you have the money verses home equity.
By saving/investing in your retirement you can become financially independent sooner. Also, maxing out your Roth IRA contributions gives you access to your principal "penalty free" if you need it in the future to pay your mortgage or for other emergency life events. This is not true with home equity.
- Is the equity in your home gaining any interest? No. The equity in your home is essentially stagnant money. You are actually losing out to inflation. Ric Edelman puts it this way, "You wouldn’t stuff ten grand under your mattress, so why stash $400,000 in the walls of the house?" - good question you need to consider.
- Psychological: The main benefit for paying off a mortgage I see everywhere concerns the psychological benefits of not having a mortgage payment. "Debt is bondage", says Suzy Orman. My opinion on that aspect, grow up financially (education) and take control of your emotions with respect to money. Read the book, You Are a Badass at Making Money by Jen Sincero. Becoming financially independent frees you from bondage; being debt free doesn't if you still have bills to pay and limited liquid funds to pay them.
What I've Learned - Model Results (for our finances)
I learned it is not financially wise for us to pay off our mortgage early. When I consider the real estate tax deductions, retirement contribution tax deductions (lowers current tax bill), a conservative investment return of 5% (low risk) for the money I don't use to pay mortgage principal early, I end up with more money down the road.
I've heard Ramsey's argument that the "low risk" option is paying off your mortgage/debt verses saving/investing. I don't agree based on doing the math and further researching the topic. I don't agree at all.
I've owned rental property for 30 years and it goes up and down in value just like the stock market - there is risk involved. Real estate is very cyclical. If you pay off your mortgage, you are still at risk of losing your equity value. We can't easily (or cheaply) access our real estate equity, especially as interest rates go up. Interest rates are going up for sure folks.
Realize you won't get OPM (Other Peoples Money - mortgage company) at today's low rates anytime in the near future, if ever again. Also, online savings accounts are paying 2.25% interest already. The interest rate will likely continue to go up annually during the next decade. The mortgage companies will hope you pay off your low rate mortgage early. That, in itself, should be a clue.
Right now, you can find numerous low risk investments, or at least as low risk as real estate. If your mortgage rate is 5% (or lower), you are more than likely better off saving/investing the funds you would use to pay off your mortgage IMHO. I did the math for us. Paying off our mortgage in lieu of saving/investing conservatively results in having a lower net worth over time. It also increases our risk of not having money in the bank to weather the storms in life.
Our investments give us tax deductions and a bigger net worth over time. In addition, our savings/investments have grown to the point where we don't need to worry about paying our mortgage for years and years to come.
Not sure about this? I wasn't either until I did the math, researched the topic, and spoke to professional financial advisors I could trust.
A few years ago, I was paying huge amounts of principal on our mortgage to pay it off as quickly as possible. I followed the herd without doing my homework first. This was a big mistake given our low mortgage interest rate and the stock market returns during that time. I stopped aggressively paying off our mortgage immediately after becoming educated on the topic and doing the math for myself.
It appears paying off your mortgage is debatable for many. Let's see who else has done the math with respect to paying off low interest mortgages verses saving/investing. Ric Edelman for one has an analysis based on what appears to me to be sound financial modeling. Although I don't agree with everything Edelman says, his math associated with NOT paying off your mortgage is worth your review. Read, 11 Great Reasons to Carry a Big Long Mortgage by Ric Edelman.
Clearly, it doesn't make good financial sense for us to pay off our low interest mortgage in lieu of saving/investing. Our mortgage is the cheapest money I will ever see in my lifetime and I'm tempted to get more.
You Are a Winner
Still want to pay off your mortgage? Either way you go you’re a winner. In addition to the positive psychological impact, those that pay off his/her mortgage early are definitely winners. You’ll save tens of thousands in interest payments over time.
Those that save/invest the money are big winners too. They’ll have more “liquid” funds (no cost/interest) for unexpected life events, a greater net worth over time, and they'll reach true financial independence sooner.
It’s not an easy or straight forward decision for many nor was it for me. In the end, we decided to do a little of both. Now that we built up a significant saving/investment account, we do pay a little extra on the mortgage every year and we'll save thousands in interest over time. It is important to note we now have enough saved/invested to pay our mortgage for years with no additional cost to us. We have a portion of those funds parked in online savings accounts (i.e., Barclay’s, Discover, etc.). Those funds are growing at 2.2% interest (no market risk).
Note we were also able to increase our retirement account contributions to lower our taxes as our income increased over time (i.e., SEP, Solo 401(k)). These funds are not as liquid, but the money we saved in taxes is invested and it is growing.
I'll admit, there are lots of variables to consider. The right answer may be different for you. It really depends on your own personal situation and level of comfort with money management. The more comfortable you become with money management through financial education, the easier it gets.
Glad to answer questions so please feel free to comment below. Thanks for stopping by - #FIDO.
Retirement Financial Planner Spreadsheet Financial Independence - helps you plan and do the math associated with retirement planning.
11 Great Reasons to Carry a Big Long Mortgage - Ric Edelman, Financial Engines
Should You Pay Off Your Mortgage Early? - The Finance Twins, Tom Madison; after reading Tom's post I was inspired to write the article above to share what I've learned about paying off your mortgage early.
Pay My Mortgage Off Fast – Does The P.I.L.L Method Work? Have you ever heard of P.I.L.L. for mortgage payoff? Does it work for paying down your mortgage? Good read that includes the math behind the concept (the math indicates P.I.L.L. doesn't work).
Dave Ramsey Thinks You are too Undisciplined for Good Financial Advice - The Money Geek, Michael Dinich