Should I Pay Off My Mortgage Early?
Topics: Better returns, Emergency cash, Inflation hedge, Interest rates
Oh, how times have changed since I first wrote this post nearly four years ago - at least interest rates have changed...my thinking on paying off your mortgage has not.
Unless you financed the purchase of your home in the last year, you most likely have a VERY LOW interest rate. In fact, according to a recent report, 99% of homeowners had a mortgage of 6% or less. Of those, 28% were below 3%(!) and 72% were at or below 4%.
So if you are thinking where you should put excess cash beyond savings, you might consider paying down mortgage debt. But is that the right thing to do? I’m inclined to say “No” – but again there are plenty of caveats and the answer is investor-specific. I’ll review a few reasons why it might make sense to pay off your mortgage early but my focus here is clearly about why you shouldn’t. Either way, if your long-term strategy is to reduce debt, I would encourage you to make sure savings are on track (emergency fund, retirement, college, etc.) and other debts have been paid off (credit cards, student loans, automobiles, etc.) before considering reducing your mortgage debt. If you don’t really have a long-term strategy and haven’t created goals or a long-term financial plan, we should talk: email@example.com.
On a Personal Note
We got a mortgage when we last moved in early 2015. I feel pretty lucky to have locked in at 3.25% and thought a refinance was nearly impossible. But sure enough about three years ago it made sense - plus we pulled out some cash to start a new construction business! We have a pretty clear savings plan and future goals that drive that plan, and my construction business is part of that. At this point I would rather stockpile any extra cash to grow that business or look for additional investment opportunities - particularly given today's interest rates near 7%. That's why I have no interest in paying off my mortgage. What about you?
Well, paying off a 3.25% mortgage is like saying you can’t find a better return than 3.25%. NOT paying off your mortgage is like borrowing at 3.25% to have the option to invest in an asset that returns x% (with x being something higher than 3.25%!). What if you could invest in an asset that can make your mortgage payment for you? Or at least provide additional income to partly offset your monthly payment. Surely, I can do better than 3.25% over the next 10 years. Long-term investing in the stock market returns somewhere around 10% annually while you could probably find a fixed income product that would at least yield 5% a year with relatively low risk. Or my favorite – real estate (I’d look for 10% cash on cash returns), which also has more favorable tax implications and appreciation potential! We discuss this in other blog posts. I do see a scenario where I could pay off my mortgage early, but not for a long time. When I “retire” I want to own my house outright, but a lot can happen in the next few real estate cycles and it’s possible that even then paying off my mortgage won’t make sense to me.
If you don’t have a plan for your mortgage debt reduction (regularly putting $500 extra toward payments, bi-weekly payments, etc.) or a very short-term goal of completing the payoff (0-24 months – ie before the next downturn), then you would probably be better off stashing cash above the normal 3-6 months emergency fund you should have in place. Maybe instead of contributing toward the reduction in your mortgage put 12 months of house payments in a separate savings account. Use that to draw from in an emergency (medical, job loss, etc.) because if you’ve accelerated your mortgage paydown and need funds you may need to borrow against your house in an emergency (or worse – credit cards). It will cost you to borrow in this way (basically asking to get money back you just had) and credit in terms of both ability to borrow and amount you can borrow will likely be less available in a downturn if the last cycle was any indication. If you are irregularly throwing cash at reducing your mortgage, I would at least consider a more specific plan. Yes, you will benefit maybe in year 28 of a 30-year mortgage, but you aren’t lowering your payments and its less cash you have if you truly need it for an emergency.
Furthermore, your mortgage debt is a hedge against inflation. What? I sound like an economist! If you’re already bored skip to the last sentence of this paragraph. But…with inflation now well above the 2% annual Federal goal), costs of goods and services continue to rise. But I continue to pay my mortgage (principal and interest doesn’t change over the life of the loan for a “fixed” rate mortgage) in 2020 dollars. That's confusing but basically, if you can lock in the same payment for a long time, and prices of everything else is going up, then that’s a good thing!
Historically low rates...gone
What we aren’t really measuring here is risk. Or personal comfort. I appreciate those that are working toward being debt free. And we have recently shifted away from a historically-low interest rate environment and many consumers are still in shock. Mortgages in the last decade have generally been under 5% for 30-year terms and better than that for 15-year mortgages - but now are more like 6-7%. So if you wanted to refinance your mortgage, it would only make sense maybe 1% of the time (according to the aforementioned study).
What is the downside?
Owning real estate in the last downturn left me scrambling to see how quickly I could reduce my debt. What I’m better prepared for this time is that I’ve done the math up front on my investments and I’m in a better overall net worth/debt/income position and current/future expenses are better understood. So while now it may not feel good to own real estate and/or have debt, it might also be a time to seek opportunity. If interest rates go down, I have additional opportunity to borrow at attractive rates for future growth. If interest rates go up (like they have in the last year because of inflation), the rent my tenants would be required to pay, and subsequently the value of my property, also went up. But my mortgage payments remain the same!
So…why consider paying off your mortgage?
There are several good reasons someone might eliminate debt ahead of schedule. The most common is probably the sense of security you would feel from owning your own home and no longer sharing with the bank. That would obviously open the door for further investment opportunities as long as you were directing the additional savings toward something more meaningful than your cash stockpile.
Along those lines, if you have a commission-based job and income is volatile or if you feel the position itself is at risk through the business cycles, I can appreciate the security factor of not wanting to employ debt on your primary residence. However, I discussed the options around using other assets to help pay your mortgage, and while I value the opinions of those looking to be Debt Free, I personally am aiming for Financially Free.
Additionally, if your loan is nearly paid off and you have some trivial amount remaining or the debt would be retired in 12 months anyway, it probably makes sense. Admittedly, I did pay off our last two automobile loans when they had less than a year to go, albeit somewhat reluctantly. Both had interest rates below 2%, and since you can now make 5% on cash sitting in the bank, that would be the wrong economic decision. But it was near the end of the life of the loan, I wanted to be done with it and I could further ramp my savings rate.
As I mentioned as I approach retirement, I’d like to not be burdened with monthly mortgage payments, so for those nearing retirement, eliminating that mortgage payment could be pretty appealing. Assuming your mortgage is truly the only remaining debt you have, and all other investment accounts are properly funded, then it could make sense to retire mortgage debt early to minimize your monthly expenses heading into or preparing for retirement.
Lastly, if you have not moved or refinanced your loan in the last decade and are paying a higher interest rate, then an early repayment of your mortgage could be valuable, though you may have another opportunity to refinance in the future - don't miss it this time. But if one or more of these other reasons apply, then paying off your mortgage could make sense.
In summary I hope to have provided a better understanding of differing uses of cash if you are considering the option of paying off your mortgage early. Again, I believe each situation is specific to the investor. I want to illustrate the use of debt as a tool, not something of which we should be fearful. Yes, there are risks, but very few people can live life without using debt, at least in their primary residence. The alternative is paying someone else’s mortgage in the form of rent until you could save up to buy a house for cash. In today’s world, I’ve not heard of anything like that. Plus, I don’t want to be the borrower. I want to be the bank, so if I’m borrowing at low rates to create value for myself and others by providing them housing, that seems like a good thing.
If you or someone you know has any financial-related questions, I would love to have a conversation, so please feel free to reach out: firstname.lastname@example.org
And please don’t forget to view our prior blogs:
And stay tuned for our upcoming blog posts where we discuss Financial Independence/Early Retirement.
Best wishes on your financial path!
This post was created by Matt Beeby, the Founder of MHB Advisory Services. Matt has been working in Financial Services and investing in real estate since 2005, though his investment experience spans nearly two decades. He is a Christ follower, active in both his church and his neighborhood association. Matt enjoys sports and family time. Read more about Matt on his website bio.
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