Paying off your Mortgage early
Seems to me that if one could pay off their mortgage early (earlier than 30 years) it would be a Good Thing (tm). The argument that the tax write off we (American's) get for paying mortgage interest is specious. You get a $0.35 tax break for the privilege of paying the mortgage company $1.00. How is that useful? If I pay $10,000 in a year in just interest, I get to (this is a simplification, really I adjust my gross) write off $3,500 in tax, but I'm STILL out $6,500. That $6,500 could be working elsewhere.
I googled some, thinking the experts on tha intraweb would have something useful to say. This only confirmed that I can get better advice from any public bathroom's wall. Note "Ask Kim" provides different wisdom based on the season.
I did like these reasons though:
Here are a few reasons for Paying Off Your Mortgage Early:
- You want more than anything to be 100% debt free.
- You want to have more choices and options for your future and no debt gives you this option.
- You want to retire early. With no mortgage payment, you can save up for retirement faster and quit sooner.
- You want a guaranteed rate of return. Paying off your mortgage guarantees you that savings rate. Investing in the stock market can never guarantee you anything.
You don't itemize but take the standard deduction. You live in Canada or another country where these is NO tax benefit to carrying a mortgage.
- You are disciplined enough that once you have paid off your mortgage, you will invest the same payments into a retirement fund until you have enough to meet your retirement needs. (Remember, with no mortgage, your required retirement income will be greatly reduced.
These resonate with me. Why sell a house that's appreciated 200% when a comparable house has ALSO appreciated 200%? I figure
99% 97% of Americans that own homes also have a mortgage (An official out-of-the-butt-made-up-but-must-be-true Scott Statistic) and that debt fuels the economy. I haven't the chutzpah to go off the grid, but paying of my house would be a start, at least we'd be off the "debt grid."
Even making one extra payment a year can trim SIX YEARS off a 30 year mortgage. Of course, to do this one has to stop consuming. I wonder if a significant number of folks stopped drinking Frappacinos and put the extra money on their mortages if the economy would grind to a halt.
Scott Hanselman is a former professor, former Chief Architect in finance, now speaker, consultant, father, diabetic, and Microsoft employee. He is a failed stand-up comic, a cornrower, and a book author.
Your 99% of people owing on the home is close, the surveys suggest it is closer to about 97%. 3% of Americans own their home free and clear.
I love your blog and thanks for all of your wisdom.
Also, the one thing that worries me a bit is that the mortgage company doesn't care that you're paying off early. If for some reason you can't make a payment, they probably don't care that you've already paid more ahead of time... they could still foreclose, etc.
If you are really risk adverse, you might be able to beat the interest on your mortgage with something like a CD or a money market.
(I'm not a financial advisor, but I play one on TV.)
Debt is bondage as far as I'm concerned. My wife and I paid off our home this year, and it does make you feel free.
as far as the 'stop consuming' bit ... i'm one of those people. just about everything i own could fit in a mid sized car. this doesn't exactly map up with small business taxes though. it's really hard for me to spend money to get the tax deduction.
I'm not offering that as a definitive reason not to pay off, I'm throwing it out there so someone can dismiss it.
Glad to see the post on this! Maybe we can get hanselman.com converted in to a PF blog! :)
I had a girlfriend that kept paying extra on her 7% mortgage, while she had 19% and higher loans outstanding. It drove me nuts.
If you can handle very low risk, buying a market index fund and holding it for 10 years is about as safe an investment as you can make. The market's never been down in any 10 year period in the history of the market, and returns average upward of 7%. If you sell those shares post-retirement in lower income years, you can do it gradually and pay less tax. If you don't have a 401(k) you can also defer some more taxes and invest through a Roth IRA.
That mortgage is the cheapest loan you'll ever have. Paying it off early will earn you far less money than just about any investment.
~get $1000 saved up
~start paying off credit cards, etc
~get 3 months salary saved up
~pay more into retirement
~start paying off mortgage
~retire early =)
My wife and are are in the 28% tax bracket and have about a 5.5% fixed 30 year loan on our house. (We are only a few years into it.) We have enough savings that we could pay off about 1/2 of our loan but instead we choose to invest that elsewhere mainly in a reasonable spread of mutual funds. Over the past few years, we have averaged about %15 in the market. In addition, each month we put the equivalent of about 60% of our mortgage payment into into our investment account.
Now I know that the 15% will go up and down but I strongly believe that it will average above the 5.5% that we are paying on our mortgage. for now, we are comfortable with the added risk that we are assuming. If we loose a significant amount in the market, we would have been better off putting all of our excess money into our mortgage. We don't believe this will happen and sleep soundly at night.
A Grinding Halt.
1) Cuz of the debt/economic factors you point out.
2) Cuz all those people would looze their caffeine buzz... and Gross Domestic 'output' would tank ;)
Personally, I've decided not to buy (again) until I'm fairly certain I'm in the house I intend to retire in. Given my penchant for moving around, I've found it is wiser to rent, especially in NJ, where I can get a place for rent that I couldn't possibly afford to buy. :) But yeah, I know, this is only marginally on topic, so I'll stop now...
But, I did read a good book recently, entitled "The Millionaire Next Door," which studied common traits/practices of Americans who have earned a lot of wealth. You might find it interesting (and it's a light read) -- I trust the advice of wealthy people more than random financial advisors. The wealthy recommend 1) get a "small," reasonable mortgage and 2) rather than pay off the second-cheapest loan you'll get, invest the money elsewhere, epecially if you have 20+ years to go.
If you invest that extra money at better than 4% instead of paying early on the mortgage, you can turn around and pay the mortgage off earlier using that money than you can by paying the mortgage all along.
According to a 2001 study by the Census Bureau and the Department of Housing and Urban Development (HUD), "nearly 40 percent of all residential properties in the United States, owner-occupied and rental units, are not mortgaged but are owned free and clear."
1. You want more than anything to be 100% debt free.
Why? If I have the ability to borrow lots of money at low interest rates and invest it wisely, I definitely want to borrow a lot. If my habits include spending excessively on luxury items that depreciate quickly then for my financial health, I should minimize my debt.
2. You want to have more choices and options for your future and no debt gives you this option.
If I have good financial discipline then my borrowing more means I have more money to make good investments. No debt means less money and less investment choices.
3. You want to retire early. With no mortgage payment, you can save up for retirement faster and quit sooner.
Again, I can invest more money if I borrow more money. If I decide to retire and simplify my life, I can gradually liquidate my investments and pay off my debts. If I accumulate more debt and invest well, I can retire even EARLIER.
4. You want a guaranteed rate of return. Paying off your mortgage guarantees you that savings rate. Investing in the stock market can never guarantee you anything.
If my mortgage interest rate is low enough, I can be confident that I can do better in the stock market, though I agree there is no guarantee.
7. You are disciplined enough that once you have paid off your mortgage, you will invest the same payments into a retirement fund until you have enough to meet your retirement needs. (Remember, with no mortgage, your required retirement income will be greatly reduced.
If you are this disciplined, you can also try to get a low mortgage interest rate and invest wisely so your return in the market outweighs your mortgage rate.
I don't thing that debt is necessarily a bad thing. Running up excessive credit card debt and taking out high interest rate loans to pay for luxury cars, vacations, and an elite lifestyles is poor financial discipline. Getting loans at a reasonable interest rate so you can use money to invest wisely in the market can be very beneficial.
Before making a decision on whether to take out a loan or pay off in advance, you need to really make sure you can make wise decisions with extra money in your bank account.
E.g., I purchased a new car two years ago. It would have been wise for me to by a one or two year old car at the time, but the deals on used cars weren't very good and I got a fantastic deal on a new one. I borrowed most of the money to pay for it at a rate of 2.9% APR. I could pay off the loan in an instant, but I have a bank account that is giving me an annual interest rate above 4%. I'd be an idiot to pay anything above my required monthly payments on my car loan.
1. I can't argue with this. It's purely a matter of personal values.
2. How does it give you more choices and options? If you can pay off your house, you always have the option of doing so. I would argue that real estate is less liquid than many other investments meaning you've reduced your choices.
3. But most people (rightly) think of retirement as a level of net worth. Paying off your house does not suddenly increase your net worth.
4. Frankly, I think this is a repeat of 1.
I overpaid my mortgage regular -- paying $1000/month when the actual bill was $780. After about 5 years of a 15 year mortgage, I had it about 2/3rds paid off.
Then I lost my job (9/11). Since I had been putting my extra cash into the mortgage, I had very little savings. And, of course, regardless of how much equity you have in your home (Over $200,000 considering the appreciation on the condo), no one will give you a loan unless you have a job.
I would rather have a 15 year mortgage than a 30 year one. While the monthly would be more, the increase won't break you but you will save a TON on interest of the years.
I don't agree that renting is better than owning a home. This makes sense only in cities where home prices went through the roof while rents are still low... like in San Diego. Rent money is money that went bye bye with no tax benefits. A home appreciates over time and this is money that's working for you. When you retire sell your home and move into a lower cost cityor home or start a reverse mortgage where the lender would send you a monthly check.
Start reading at page 9 and continue through to 15:
It talks about early pay-off and makes a few good points. For one, a house is an investment, just like stocks, bonds, or anything else. Its value will change over time. In most places, housing is safer and has higher returns than other things like stocks. Stocks can give a good return, but are more volitile and could end up losing. While things like bonds/CDs have a lower rate of return. The housing market can be a safe in-between, where it pays well, but is more secure. So if you manage to pay your house off early, could then buy a second house and sublet it. You won't get the tax benefits, but would be getting money to help with the mortgage from the renters and would be a good investment.
There are a lot of pro's/con's, but that was one that came to mind.
Bottom line though: Get the home equity line of credit while you still have a job, because, like James mentions, no one wants to talk to you when you are unemployed. (And getting a home equity line of credit these days can be done without costing a cent)
A reason to stay in the owning game : it is all about the quality of the residence/neighbors. If I could get an apartment with nice construction where my car and my person would be treated with respect, I would do it. It gets hard to find that. I buy my condos to stay out of ghetto situations. Your mileage may vary of course.
Paying off a house early is a great way to tie up all your money and stay poor. Having 50k tied up one house, is simply a bad investment approach. A real investor would have 5k tied up in 10 houses full of renters. Use your extra money to maintain cashflow to cover payments between renters, and let the renters pay off all your morgages while you enjoy the appreciation on the houses.
Debt is only bad if it's debt on a depreciating asset, like a car, a boat, a tv, but debt on appreciating assets like houses, is good debt, you get to use someone else's capital, pay a small interest, and keep all the appreciation yourself. There's a reason real estate is one of the classic avenues to wealth.
There is a very solid argument for taking out as much mortgage as you can possibly qualify for. This is particularly true in hot markets (like Scott's).
Almost the entire beauty of a mortgage (in my opinion) is that you are building wealth on someone else's money.
While a 6% loan is really a 4% loan after the write off, (very cheap money), by the time you factor appreciation into it (Say 8% as a very conservative Portland-ish number) you are making a net gain off someone else's (the Bank's, aka "The Man's") money.
If in addition to this, you feed your 401-k, maybe an IRA and your emergency savings with the money you have left over, you end up in a position where you are building wealth not only off your assets, but someone else's too.
To me, it makes sense to leverage cheap money. It makes more sense to me because I'm not afraid to sell and move every few years as I find the right deal. Sure, the whole market appreciates but not all at the same rate. There's always a good deal if you are willing to search it out.
If our next house proves to be our last, I hope to be able to pay it off via other wealth building vehicles I have been using in lieu of paying off my mortgage early. (I still make bigger mortgage payments than I have to, but I am in now way feeling compelled to make it all go away.)
I don't like stupid debt. I do think there is very smart debt to be had and it generally involves leveraging your position with someone else's money.
My $.03 (.02, tax deductible)
You made the same assumption when you wrote, "Joshua - I hear you about the present vs. future value of money, but the money spent paying off a house still is "there" as equity and arguably a modest appreciation, especially on a house that increases its value tax free, is a better than 4% investment."
Over 10 year periods, the stock market has higher real returns than any other asset class (after inflation and taxes), including housing. That's held true since the 1920s when they started officially tracking stock market data.
After "owning" three homes, one in rent for awhile, I would propose just working through the best case scenerios (easy and fun), then working through the numbers on the worst case scenarios (scary yet important). If your strategy will survive a worst case scenario, then by all means go for it. I've seen a lot of weird things happen in real estate over time. Today's situation, on average, has everyone sitting out there on the cliff as it quickly erodes from under them. Trust me, I used to work at Centex Home Equity, where they made a business of lending to higher credit risks. The smart thing is not to spend too much time determining what you can do with your situation, just what you can cope with given changes in the entire economy and mortgage market.
I see the great advantage of equity as 1. Better resale income, 2. Better cushion against deflation, 3. More flexibility to make a profit if resale costs are high, 4. Opportunity to refinance for lower costs if you have to put the property in rent (very important as cash flow is king in this situation - and ongoing repair costs can be sizable).
Final word for what it's worth. My parents managed to pay off their house in record time. This was on a lower middle-income. They were able to invest in a lot of home improvement and later the family survived a major calamity. They sent both their kids to college. I don't think they could have done that with a "spend all the debt you can get" mentality that is common today.
Yes, it's best if home prices continue to rise, but I assume the mortgage strategy probably works out (depending on loan & house values) even across dips in housing prices - ie. assuming you hold for long enough.
This is very different than, say, a car loan - which is about borrowing money so you can fully realize the DEpreciation of a much bigger asset than you should be able to afford. Now you're weighed down by two expenses, and all you got was a few extra conveniences during your commute...
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