Part of the journey here at headquarters is removing obstacles to a life of freedom and choices. If you own a house, or have owned one in the past, you know all about the stress of having a mortgage (or two) hanging over your head.
Let’s dig into that notion of “removing obstacles” and see if we can agree that paying down the mortgage early makes good sense, or not.
If you do your research, you’ll find a lot of conflicting advice about the financial wisdom of paying off a mortgage early. Some of the best, most well-researched articles are themselves conflicted. You don’t come away with a clear-cut answer. That’s what makes early mortgage payment a tortuous decision for those of us on the Financial Independence, Retire Early (FIRE) journey.
Why Would You EVER Pay Down the Mortgage Early?
When considering the idea of mortgage pay down, the first bit of advice you’ll want to heed is to make sure any high interest loans are paid off first. If you’re carrying any student loans, car loans, or credit card debts, chances are those interest rates are higher than your mortgage.
I’m bending that rule a bit personally. We have a large chunk of student loans remaining from Mrs. Cubert’s postgraduate studies. Since the loan rate is only 2% (roughly the rate of inflation), it doesn’t make sense to make more than the minimum payment.
Current payments are about a quarter of the monthly mortgage outlay, so it’s not a big hit to our cash flow either. We can opt to tackle this loan after the corporate life is behind us.
Many well-informed folks would argue that even after you’ve paid off all your higher interest loans and obligations, it still doesn’t make good financial sense pay down the mortgage early. Let’s dig deeper…
The reason is opportunity cost
In theory, you could be putting all that good money into the stock market and realizing a yield of up to 9%. You could put that money into real estate rentals, where returns might eclipse 20%. So why not just hang onto the mortgage? Skim off the margin between your mortgage rate of say 4%, and a theoretical stock market yield of 9%, gaining you a 5% return? And that’s not including the tax deduction on mortgage interest!
This is the nut to crack for me. You need to consider that your wise accountant will capture your mortgage interest deduction in your returns. If you pay down and pay off your mortgage, you lose this deduction. Further, if you’ve got a mindset that there’s always another opportunity to squeeze more juice out of the orange, you’ll struggle to step away from a 5% margin opportunity.
Here’s the thing. You never know what kind of swing is around the corner with the stock market. There very well could be a slump like the ones that occurred in the early 90s or the late 00’s. You just can’t rely on a 9% return if your window of time to retire is a decade or less. The market is a fine venture for the long haul, like, say, 20 to 30 years or more. But at 10 years or less, you’re sort of gambling.
A pro of NOT paying off your mortgage early: You could spend a good chunk of time whittling away at the principal, but at any point in time, regardless how much principal is left, the bank can legally foreclose on you for delinquent payments. In a disaster situation where you’re left without a job and can no longer make payments, all that effort to pay down the mortgage is wasted. The bank owns your home until every last penny is paid.
Then why am I so hell-bent on paying off our house?
The main reason is this: It’s one less cloud hanging over our heads. Hard to put a price on that.
There are more objective reasons. Paying off the mortgage is like a hedge against the stock market. You’re getting a guaranteed 4% (or whatever your mortgage rate is) return with each payment. In the long term, saving tens and even hundreds of thousands in mortgage interest does not suck.
For my cubicle escape to work I need to reduce or eliminate unnecessary monthly payments from the budget. Losing the mortgage means we’ll have $800 more each month in the kitty.
Why have a mortgage at all?
Why not simply rent and avoid all the hassle? I really respect this view and understand why many in the early retirement community lean towards renting over owning. For me, I simply enjoy having a house to customizing and work on. Sadistic, I know.
There is some peace of mind not having to worry about what the landlord intends to do with the the house long-term. He or she could sell it right while you’re renting. The new owners might just want to live there.
By owning, we don’t have to worry about the rent going up. We don’t have to worry about having to move if the landlord chooses to sell. In fairness, I would subscribe to the approach Mr. Money Mustache suggests: Rent in places where home prices are obscenely high, otherwise consider owning.
So, friends, what do you think? Are you on a path to pay off your mortgage early? Or do you have a different path that involves keeping your mortgage while investing elsewhere? Comment below!
Postscript 7/3/19: We’ve paid off our mortgage early in May 2019. No champagne or anything, just a progress tracker wiped clean off our fridge white board. One less cloud!