Should you pay off your mortgage early? It's a difficult question to answer. There are many factors to consider. However, there is one easy way to make the decision. I've created a simple test to answer the question "should I pay off my mortgage early?".
Why Is It Such A Hard Question?
Vested Interest in the Mortgage Industry
In the old days, this was an easy question. Everyone tried to pay their mortgage early. However, the realty and mortgage industry has grown substantially over the years. We now have many so called "financial planners." Realtors, mortgage brokers and financial advisers all have a vested interest in making sure you have and keep a mortgage.
- Mortgage brokers and banks obviously want you to have a mortgage. Mortgage payments are extraordinarily safe income (defaults on mortgages are historically very low) for them each month.
- Realtors get a bigger commission check with a larger mortgage. They want to push you into a large house and therefore a large mortgage to get a higher commission.
- Financial planners and advisers want you to put your money in mutual funds and stocks. Most Financial advisers (unless they're fee only) make money pushing certain investments. They can't earn fees and commissions if you pay off your mortgage instead. This is a definite conflict of interest.
Most of the people we trust to offer financial advice have a vested interest in mortgages.
Too Many "If's" in the Tax Code
Talk to someone about paying off your mortgage and the first thing you'll hear is "what about the tax advantages?" Yes, what about the tax breaks?
Here's the trick. There is something called a standard deduction. This is the fixed amount of money you can deduct from your taxes if you don't itemize. You have to itemize in order to deduct your mortgage interest. Most taxpayers don't itemize.
According to the CPA Journal:
Approximately two-thirds of all tax returns use the standard deduction. Accordingly, many so-called “deductible” items (charitable contributions, for example) do not actually affect the tax liability of most taxpayers.
So when someone tells you that you have to keep your mortgage for the tax break, tell them they're full of crap. In order to itemize you have to have enough qualifying expenses (like medical bills) that exceed the standard deduction. In 2007 the standard deduction for married filing jointly is $10,700. That's a lot of expenses for the average US household considering an average household income of $48,201.
I'm sure there are situations where the mortgage deduction makes sense. Your best bet is to talk to a CPA and find out if you benefit from the mortgage interest deduction.
The "Should I Pay Off My Mortgage" Test
This is the easiest test you've ever taken. There's one question and no wrong answer. Simply answer yes or no to the following question:
If you woke up on day and your mortgage was completely paid off, would you go get another one?
If the answer is yes, then you should keep your mortgage. If your answer is no then you should pay it off. It really is that simple.
But I'm Smart, I'm Putting My Money in the Stock Market Instead
That's fine; you should do what makes sense for you. You might want to read this Wall Street Journal article about the lost decade of the S&P 500.
The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.
The fact is paying off your mortgage is a 100% safe investment. You can't lose money paying off your mortgage. Stocks are not guaranteed. I'm invested in the stock market for the long run. However, I paid off my mortgage for the short run.
But I'm Really Smart, I Qualify for the Deduction
Congratulations, you've figured out how to spend a dollar to save 25 to 35 cents depending on your tax bracket. I'm in awe of your genius.
I'm sarcastic to illustrate a point. How are you saving money by spending money? It doesn't make sense to me.
Do What You Want
The point of this article and the over simple question is that you should do what makes sense to you. Personal finance is 90% psychological and 10% economical. You need to feel safe about what you're doing.
If paying off your mortgage gives you an enhanced feeling of security, then you should do it. However, if you've convinced yourself that you can make more money in the stock market, then you should do that.
What do you think? Have you paid off your mortgage? Do you want to? Leave a comment and let me know what you think.
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Comments
17 Comments so far
How can you choose one option (paying off your mortgage) without first ascertaining the risk and reward for all of your options? Your dismissal of investing the stock martket based on one arbitrarily selected period of time is laughable…why 9 years? Because it supports your pre-determined conclusion?
A better estimation for the long term (30 year) expected return of the SP500 should be based on its long history. This website(http://politicalcalculations.blogspot.com/2006/05/sp-500-best-average-and-worst-returns.html) has a nice calculator that will tell you the highest, lowest, and average return for any time period. Thus for every 30 year period since 1871 the SP500 averaged 9.4% return, with a high of 16.4%, and a low of 4.1%. Thus, over every 30 year period of the SP500 since 1871 the lowest return ever received was 4.1%. Since my mortgage interest rate is low (<6%), I'll take my chances that the SP500 outperforms my mortgage interest rate over the next 30 years. Plus I'll diversify (in small stocks, EAFE, REITs, and bonds) and annually rebalance, which should let me be able to beat SP500 over the long haul.
I think paying off a mortgage is a good idea but for a different reason than you mention here. Having a mortgage means that you need to have a larger income to make that payment each month.
If you were disciplined enough to pay off a mortgage you would no longer be required to set aside that extra income for the payment each month. Without a mortgage you could quit your full-time job or set aside that money to invest in the stock market or whatever else you wanted to do. No mortgage means freedom.
Jeff,
Thanks for the information. I do enjoy your counter arguments.
I chose 9 years because that's how long I've been investing in the stock market so it dovetails quite nicely with my argument. It also illustrates the fact that the market repeatedly enters dead zones where it performs rather poorly and true gains are infrequent and irregular.
I have a question for you. First I'm assuming you have a conventional mortgage and you are making monthly payments thereby creating a small amount of equity in your home each month.
If that's true, do you also have a line of credit based on the equity in your home (second mortgage, etc)?
It would seem to me that if you believed the stock market was a better investment you should either obtain an interest only loan or an equity line of credit.
If your argument was correct, you would not pay off your home; instead you would invest that money in the stock market.
I’m curious if you or someone you know does that. It would be a fascinating experiment.
Thanks for reading!
Chris,
That is an interesting idea, but not one that I think would be feasible for me to try.
I would expect that interest rates on 2nd mortgages and interest only loans (not used for the purchase of your home) would be fairly high right now–I would guess around 8%-9% or so if you had good credit. Plus, it would probably include loan fees.
Assuming I could get a low rate (5-6%) with little or no loan fees, there are a couple more risks with this strategy that would make me think twice. The first is that interest only loans (HELOCs) have a fixed period where they are interest only (5-10 years), after which time you need to either repay them or refinance. Since in the short term stock prices can behave much differently than their long term return (as illustrated by in the last 9 years), I could lose money in the stock market and not be able to fully pay off the 2nd mortgage when the payments increase. Secondly, I would also run the risk that my home value would drop (puting me upside down), thus severely limiting my refinance options. It just seems like an awful lot of risk to take on…especially when your return is speculative.
However, when you have a 30 year fixed mortgage (and don't have to worry about refinancing) you have a time horizon that allows you to reduce the speculation of your return or risk. This reduction in speculation allows you to make a reasonably prudent investment decision, i.e., taking on a little extra risk to receive a little extra reward.
I agree.. I would pay off my house first then use the paycheck for doing whatever.
Right on! Always pay off all debt before investing. Always choose freedom.
I have a close friend (73), widowed one year, with a $114,000 6.4% mortgage balance on a condo worth $180,000. She has investments in excess of $300,000, long term care insurance, and lives comfortably on SS and pension. She wants to refinance. I am trying to convince her to pay off her mortgage. Her finance guy (who also holds her investments) says "no." Her tax man also says "no." She says she might need the money someday. I tell her she is paying interest today on something she "might" need somday. I tell her she could always get a home equity line of credit if she needed it. I am going to print your article and try one more time before we go to the bank for refinancing. HELP!
Nobody ever talks to the impact of tax deductibility when you factor in the AMT hit.
The tax deduction for interest on you home is eliminated in the AMT calculation and you end up paying tax assuming you already paid the mortgage off. So I see no tax savings in the decision. I paid mine off 8 years ago.
I am 32 years old and hate debt. My wife and I bought our house 5 years ago for $130,000.00 and now I only have 2 payments left. I have always hated looking at my monthly statement and seeing my $980.00 payments and only seeing about 140.00 going to principal. I have been investing in the stock market the whole time during my mortgage and seeing my money invested cut in half. My finical advisor always told me not to pay it off early but I don’t think he was truly looking out for my behalf. I am so happy knowing that in 2 months I am done with something that takes most people a lifetime to do. It was not easy getting here. I worked allot of extra hours and stayed home taking in movies and cooking at home. So not my money is now my money. I know I will pay in a bit more in taxes but now if my job goes under I would not worry too much. My wife can stay at home with our kids and raise them our way instead of a daycare doing our job. For me It makes sense.
When I was growing up my parents kept a ledger listing every penny that I had borrowed from them. Whenever I received payment from a job or for chores, my Dad would ask me how much of my paycheck was I going to put towards the money that I owed him. This lesson has taught me to hate debt. Paying off the house was the last item that my wife and I were making payments on and we were able to do this by the time we hit 40 yrs old. I realize now that its not about how much money you make, but how much you save. Think about it, if you could keep 40,50,60 cents of every dollar you make what a sense of freedom and empowerment that would give you. For us, paying off the mortgage was what made sense to us.
Times are shakey right now. I'm thinking of taking money from a low-interest savings acct and paying off my condo. The "non-financial" gain for me is if my job is lost I can probably manage just fine on half my income. I can stop living in fear every day. Minimizing the possibility of losing my home in the situation is huge benefit. Think thru how you would manage the worst case scenario with a mortgage over your head and without. Without a mortgage, it's still bad but not crazy bad.
I really liked this article. And I really liked the comments. Thanks.
My husband is 67 years old and thinking of retiring in the next year or so. He is a clergyman and has never made a large amount of money. We have been married for 40 years and that entire time we have lived in a church rectory. About 20 years ago we invested in a small summer cottage. It has been a wonderful place for our family to enjoy in good weather. Our daughter who has always loved the place is presently living there. We purchased a home in July 2009. The cost of the home was $260,000.00 — thanks to our parents' inheritances, we were able to put all but $90,000.00 down on the house. Our monthly mortgage payment is $766.31 — there is no problem making this mortgage payment at the present time; however, when my husband retires, his SS will only be $815 per month. I do not have enough quarters of working to get social security. I am 58 years old so either I will get a job after my husband retires — I can't get one now because I babysit everyday for my 2 grandchildren or we'll have to withdraw from our IRA. The total amount left today is approximately $165,000 in our IRA accounts. Our cottage has been appraised at $178,000 as of July '09 (we originally paid $28,000 for it) and we have a rental property recently appraised at $375,000 (we owe approx. $70,000 on this).
The question is — should we take the remainder of the balance on our new house HELOC loan and pay it off or just keep making the payments? We took the home equity loan out for 15 years. We have an elderly tenant living in the house while my husband is still active as a clergyman — she is 95 years old and pays $1000.00 per month (utilities included) rent. We put her rent directly onto the principal of our loan while we make the monthly mortgage payment of $766.31 – -what is your opinion? Should we pay off the mortgage or keep going as we are? I'm so worried that the market will drop again and we'll just watch what we have left disappear into smoke! We need your advise. Please give us input on this matter.
Thank you!
I have a quick question.. How about paying off all or most of your mortgage payment from the HELOC. I have a 15 yr 5.375 fixed mortgage. I have 12 years left. Right now my payment goes 50% to principal and 50% to interest. I also have a HELOC which is below prime (2.75%, 20 year, 10 year draw). If I pay off all or most of my mortgage from the HELOC, my monthly payment goes down and also total amount paid goes down. Should I do it? I am worried if my FICO score is going to be ruined. Also, I plan to get new mortgage to buy a place since I got married recently. Any suggestion will be great help. Thanks in advance … DB
I AM 72 MY HUSBAND 75…WE OWE $240,000 ON THE FAMILY HOME WE HAVE USED FOR A BANK FOR THE LAST 40 YEARS SENDING OUR 6 KIDS TO COLLEGE ETC
I NOW DONOT WANT TO HAVE T KEEP UP WITH THE $2400 MONTH OUT OF OUR $4800 MONTH RETIREMENT CK. FOR MGT PAYMENTS…WE OWN A COUNTRY HOME NO MGT…AND MY MOMS HOUSE WITH A $40,000 MGT…I WANT TO SELL THAT AND PUT WHATEVER IN SAVINGS.
THIS WOULD LEAVE US WITH ABOUT $2,5 MILLION IN PROPERTY VALUE AND NO WORRIES ABOUT KEEPING UP WITH PAYMENTS.
I AM ONLY GETTING 3% ON SAVINGS AND MONEY MARKET AND I HATE WORRYING ABOUT WHAT IS WISE AND WHAT IS NOT….
AM I FOOLISH TO PAY OFF THE MGT…IT CERTAINLY FEELS RIGHT
I can't wait to pay off my mortgage. I even setup a blog as a reminder and for encouragment on paying off my house. http://www.payingoffmyhouse.com if anyone wants to follow my journey.
I have read about the pros and cons but the cons, at least in my situation, don't outweigh the pros. I have also read a few articles about the lost decade in the stock market, and I don't think we are out of the woods yet. I am planning to play it safe and build equity in my house. I really liked this part from your page.
"If you woke up on day and your mortgage was completely paid off, would you go get another one?
If the answer is yes, then you should keep your mortgage. If your answer is no then you should pay it off. It really is that simple."
If my house was paid off I wouldn't be running out to upgrade or get another mortgage. I will hopefully be able to refinance to a 15 year loan and then try to put everything I can towards principal.
Would you mind if I linked to your article from my blog?
My mother knows someone who invested with Madoff. She was a multi millionaire but was convinced to keep a car payment and mortgage because Madoff could "make her more money" in the market. Well we all know how that turned out and this lady is now literally homeless. I understand that this is a rare situation and sometimes you could make more in the market- but it was a good lesson for us. My father is an investor and the first thing he did when he made money is pay off his house- the first thing we are doing with a lump of cash is paying of our house. In this economy we want to know that no one will be able to take our home. (We don't use credit cards either) Obviously not everyone is in a position to do this, and I would say it is mostly emotional- but that is fine with us.
My wife and I paid-off our home almost three years ago. The day the last check cleared it was if a yoke was removed from my neck. The money we used to spend on our $1900 mortgage has been split between saving and improving our home. I say don't listen to your broker as paying-off your loan is a SURE investment!