Tell me why I shouldn't pay my house off

[Manguy888]

Hey all,

My wife and I have worked our frugality muscles to the point that we think we can set aside $50k per year toward savings and investments (this after filling up my 401k). Our mortgage has 180k left on it: is there any reason we shouldn't just spend the next 3.5 years paying down our mortgage, then start directing this stream toward our investments? Once the house is paid off we'll have 1000 less in expenses, which can be put toward extra investing.

My mortgage rate is 3.9%, and I know mathematically that the money will do better than 3.9% in the stock market. But why not just pay the house off, get rid of that uncertainty, and invest from there? Anybody?

Let me know why I shouldn't do this, as it deep down just feels like a great plan.

[MooseOutFront]

I think that's fine, but I wouldn't do it.  I want as big a chunk of income producing investments as possible compounding upon itself as soon as possible.  Plus my expected returns on this money will be higher than the interest paid on the mortgage in your case.  I don't want my mortgage paid off until I'm done trying to accumulate savings.  Once that number is big enough for FIRE then I can look at mortgage reduction as a new goal.  If I did the mortgage reduction first it would delay my FIRE date.

[Frankies Girl]

Paying off a mortgage when the interest rate is low means that you're using money that could be invested and earning you a higher rate of return than the mortgage interest rate is costing you. So you're both locking it up in a less liquid format (your house) and you're losing the time that the investment would have been compounding and growing in addition to that interest rate earning power.

You can of course get a HELOC to pull out money if needed, and it's a great way to tap the otherwise locked in money in your house... but logically it makes more sense to just keep paying the regular mortgage payment and take extra money and throw it into investments that will outearn and grow over time. Time is one thing that is very precious in investing, and you can't get that back, so that was the biggest reason I decided against paying off my (much cheaper than your) house any time soon.

But then again, it is a deeply satisfying paying off your house, and knowing that is 100% yours (less the taxes!) so you would really have to weigh that comfort/feeling against the returns on investing and sticking to the mortgage schedule.

[skunkfunk]

I know it doesn't usually win mathematically, but paying off the house is a safe investment. You are getting a guaranteed return of 3.9% on that money, essentially. It is good for a portion of your investments to be safe, and that is a great one. You're not investing in the house by paying it off early - you've already got a lot of capital tied up in the house. You are investing in the loan, and the interest payments you will not be making on it.


That's my reasoning. That, and I will feel better with lower expenses (no mortgage) than with more income (capital gains).

[BFGirl]

I would pay off the house.  There is a lot of peace of mind in knowing that your home is free and clear.  You also can't predict what investments are going to do in the future.  I would take care of the house first and then you have more freedom to invest later when a downturn isn't so devasting to your financial independence.

[huadpe]

I would put some extra towards your mortgage, but perhaps not all of it.

Essentially, your mortgage is an opportunity to buy a bond at a better than market interest rate.  So whatever portion of your asset allocation would go to bonds should instead go to mortgage.  You might even plus up the amount you'd allocate for bonds given you get the extra above-market rate boost.

Re: taxes, you also need to figure that you don't have to pay dividend or cap gains tax on the interest you don't pay on your mortgage.  If you're already itemizing and are in the 25% bracket, that basically nets a 15% benefit to not paying off the mortgage tax wise, so about 3.4-3.5 effective after tax APY versus a taxable investment.  Better if you wouldn't be itemizing without the mortgage interest deduction.

[zhelud]

We paid off our house about 2 years ago.  Every single month, I get a thrill knowing that I did not just send Bank of America a bunch of money, and I never have to again. Maybe this feeling will wear off someday, but it hasn't yet.
I guess I could calculate how much I am "paying" for this good feeling in reduced investment income, but why spoil it?

[gillstone]

Manguy, it sounds like you've reached the best part of growing a stash - the part where you look around and say "what am I going to do with all this free money floating around".  At the point you are at its more what gives you peace of mind.  If you have enough cash saved you can walk away from your job today then go ahead and pay it off. 

[FastStache]

Let's say I plan to FIRE in ten years with a good interest rate on a mortgage, around 4%.

If I don't pay it off before I FIRE, I would lose some of the tax benefits of pre-tax 401K contributions because I would need to pull more money out per year, causing a higher tax burden.

Should the plan be to remove the mortgage right before one can FIRE?

[Jack]

First, what does your investment policy statement say? Are you conservative or aggressive? If you're aggressive, put your money in the market. If you're conservative, pay off the mortgage.

Second, keep in mind that (in some ways, at least) a mortgage can be thought of as a "negative bond." In my opinion, at least, it's almost pointless to own bonds if you have a mortgage. (I say "almost" because the illiquidity of a mortgage prevents you from re-balancing in the bonds->stocks direction. I only "rebalance" by adding new funds, so I don't worry about it.)

[NewStachian]

I would invest

- It is theoretically optimal to invest due to average returns compared to your rate - 3 years of compounding is typically thought of as small because people do the math linearly on the first few years. If you think of those 3 years on the back end, you can see how the exponential effect is so huge.
- investments provide a real income stream. A house mitigates cost and only when fully paid off
- Having secured 3.9% debt is a great hedge and reduces your exposure during a large inflation swing, which given today's monetary policy might be right around the corner.

[CarDude]

There are certain tenets on this forum where I'm always going to be in the minority, and this is one of them. I recommend paying off the house as soon as you can. Always have, always will.

[CheapskateWife]

We are looking at that too, and timing our mortgage payoff to coincide with DH's retirement from the military in 5 years.  That way, we don't loose our most signifigant deduction while our incomes are at their highest.  The extra that doesn't go to mortgage, goes to investments.

Once he drops his retirement papers, we will look like we are in the poor house from an income-only perspective....which might work out nicely as the kids are applying for financial aid for college.

[Cassie]

I agree with Carsafetyguy. We paid our home off 2 years ago and would have never felt comfortable retiring without having that paid off.  It is a great feeling and makes it so much easier to live on so much less $.

[Manguy888]

Wow! Thanks for all the great information everyone. Just to clarify our situation: we are in our early thirties, so this house payoff would not trigger early retirement when complete. We aren't there yet, and also like our jobs (most of the time). We'd ideally like to save as much as possible to retire comfortably between 45-50 years of age, so roughly 15-18 years from now. We already have roughly 200k invested but it's all in 401k and roth ira (so tax advantaged accounts with strings attached to withdraw)

[MooseOutFront]

I have a mortgage payment included as part of our retirement.  For me budgeting for this expense allows us the flexibility to move whenever we like so long as the monthly expense stays the same.  Owning a house free and clear could work the same way, but it's just a kind of mental accounting that adds to our margin of safety in my head.  Plus it allows me to be more aggressive with our current investments.

[aj_yooper]

Having a paid for house in retirement is sweet!  And, the decision is revokable-you just put a mortgage on it later, if you want.  It is a way to park your money, but go with your investment policy. 

[TGod]

My husband and I were just having this conversation this weekend. We have a set up that I deal with all the financials, cause I like it and don't get stressed out as much as he does. I keep him informed about my decisions and frequently ask for input so I'm not a one gal kinda show. So I know that he's always leaned towards the pay off the mortgage before investing, whereas since placing half a butt cheek on the MMM bandwagon I lean more towards investing.

Well he was pretty straight up in our convo, that he HATES the stock market. Thinks its the most unethical, throw your money in the garbage type scenario that there is, and that if left to his own devices he would be paying off the house and worrying about the mortgage later. Course he will have a pension so it's an easier decision for him to make.

We definitely have a line when it comes to what to do with the money. I'm meeting him in the middle with this though. I've doubled up the payments on our 240K @ 2.99% mortgage, and the rest I invest. We're still at this point putting more on the mortgage than we are investing :( though which I would really like to change.

[kmm]

For me it comes down to asset allocation. Right now, real estate equity in my primary residence and my investment property makes up 32% of my net worth. I'd prefer it not be more than 1/3, so while I do pay a bit extra toward principal on the investment property each month, I haven't made paying off either mortgage a priority.

Ultimately there are pros and cons to both and it comes down to what will help you sleep best at night. A good problem to have, overall.

[HAULIN3]

so... I'm really not up on all this stuff, and will probably be asking a stupid question, but ....

So if I pay 10,000 in interest to a stupid bank on a mortgage, I can deduct it, and maybe that would save me $2500? If I give $10,000 to a church, isnt it the same $2,500 I save??

[MooseOutFront]

so... I'm really not up on all this stuff, and will probably be asking a stupid question, but ....

So if I pay 10,000 in interest to a stupid bank on a mortgage, I can deduct it, and maybe that would save me $2500? If I give $10,000 to a church, isnt it the same $2,500 I save??

Well, a couple things here. 

1st, you can only deduct it if you itemize deductions.  We do every other year, barely.

2nd, it's not the difference between choosing to stay in debt for the deduction or not being in debt as a simpleton like Dave Ramsey would have you believe.  It's the opportunity cost of not investing those dollars in something else.  In my case every single dollar that doesn't go to pay off the mortgage early goes to investing in stocks.

3rd, that stupid bank loaned you the money enabling you to "own" a house before you saved enough to own one, so I don't personally demonize them.  Alternatively that stupid church may be pushing the state board of education to strike evolution from the curriculum. Likely so even. :)

[nawhite]

For me it comes down to asset allocation. Right now, real estate equity in my primary residence and my investment property makes up 32% of my net worth. I'd prefer it not be more than 1/3, so while I do pay a bit extra toward principal on the investment property each month, I haven't made paying off either mortgage a priority.

Ultimately there are pros and cons to both and it comes down to what will help you sleep best at night. A good problem to have, overall.

I fall into this boat. I'm pretty young so I'm targetting 75% stocks, 10% bonds, 10% real estate, 5% cash. Unfortunately though, my house is up around 45% of my net worth so I'm paying it off as slowly as possible while I try to catch up with the other accounts. (buying a house early in my staching years makes the down payment a big part of my total assets)

If you change the question to student loans instead of a mortgage so the payoff question isn't a matter of asset allocation, I maximize all tax advantaged accounts first thing ($17.5k in my 401k and another $11k in wife and my IRAs) and then put the rest towards loans. So I'd recommend you start with $11k to IRA's and then worry about the remaining $39k/year.

[FastStache]

For me it comes down to asset allocation. Right now, real estate equity in my primary residence and my investment property makes up 32% of my net worth. I'd prefer it not be more than 1/3, so while I do pay a bit extra toward principal on the investment property each month, I haven't made paying off either mortgage a priority.

Ultimately there are pros and cons to both and it comes down to what will help you sleep best at night. A good problem to have, overall.

I fall into this boat. I'm pretty young so I'm targetting 75% stocks, 10% bonds, 10% real estate, 5% cash. Unfortunately though, my house is up around 45% of my net worth so I'm paying it off as slowly as possible while I try to catch up with the other accounts. (buying a house early in my staching years makes the down payment a big part of my total assets)

If you change the question to student loans instead of a mortgage so the payoff question isn't a matter of asset allocation, I maximize all tax advantaged accounts first thing ($17.5k in my 401k and another $11k in wife and my IRAs) and then put the rest towards loans. So I'd recommend you start with $11k to IRA's and then worry about the remaining $39k/year.

Do you count the net worth as the value of the or the equity you have in it?

[Davids]

There really is no wrong answer here. With a rate of 3.9% in theory you should be able to get a better return if you invest the extra money but the piece of mind of no longer having debt is huge. I currently owe $141.5K on my house at 4.25% interest. I bought my house in 2010 and was initially just making minimum mortgage payments but have now been putting more and more towards the principal each month with a target goal of paying it off before the year 2020. I know I probably could take some of those extra principal payments and invest and probably make more than 4.25% but the piece of mind of having no debt means more. I do now max my 401K and Roth and have other taxable accounts so it is not like I am putting more at the expense of retirement.

[HAULIN3]

so... I'm really not up on all this stuff, and will probably be asking a stupid question, but ....

So if I pay 10,000 in interest to a stupid bank on a mortgage, I can deduct it, and maybe that would save me $2500? If I give $10,000 to a church, isnt it the same $2,500 I save??

Well, a couple things here. 

1st, you can only deduct it if you itemize deductions.  We do every other year, barely.

2nd, it's not the difference between choosing to stay in debt for the deduction or not being in debt as a simpleton like Dave Ramsey would have you believe.  It's the opportunity cost of not investing those dollars in something else.  In my case every single dollar that doesn't go to pay off the mortgage early goes to investing in stocks.

3rd, that stupid bank loaned you the money enabling you to "own" a house before you saved enough to own one, so I don't personally demonize them.  Alternatively that stupid church may be pushing the state board of education to strike evolution from the curriculum. Likely so even. :)

Ya, I see. The more I read the more confused I get... It just seems like one wrong move and boom...

[Sonorous Epithet]

so... I'm really not up on all this stuff, and will probably be asking a stupid question, but ....

So if I pay 10,000 in interest to a stupid bank on a mortgage, I can deduct it, and maybe that would save me $2500? If I give $10,000 to a church, isnt it the same $2,500 I save??

Both mortgage interest and charitable contributions are itemized deductions. They will only lower your tax bill to the extent that they exceed your standard deduction:

2013 Standard deductions, for reference:
 Single $6,100
 Married Filing Jointly $12,200
 Head of Household $8,950
 Married Filing Separately $6,100
 Qualifying Widow(er) $12,200

For each dollar that you increase itemized deductions over your standard deductions, you will indeed save your marginal tax rate. In your example you assume a 25% tax rate.

But really, how often do people choose between paying mortgage interest and paying charitable contributions? The decision would really only come up if you are thinking "If I pay off my mortgage early and give the amount I would be putting to interest  to charity, would I be able to have the same tax bill?" This seems a little nonsensical to me.

[kmm]

For me it comes down to asset allocation. Right now, real estate equity in my primary residence and my investment property makes up 32% of my net worth. I'd prefer it not be more than 1/3, so while I do pay a bit extra toward principal on the investment property each month, I haven't made paying off either mortgage a priority.

Ultimately there are pros and cons to both and it comes down to what will help you sleep best at night. A good problem to have, overall.

I fall into this boat. I'm pretty young so I'm targetting 75% stocks, 10% bonds, 10% real estate, 5% cash. Unfortunately though, my house is up around 45% of my net worth so I'm paying it off as slowly as possible while I try to catch up with the other accounts. (buying a house early in my staching years makes the down payment a big part of my total assets)

If you change the question to student loans instead of a mortgage so the payoff question isn't a matter of asset allocation, I maximize all tax advantaged accounts first thing ($17.5k in my 401k and another $11k in wife and my IRAs) and then put the rest towards loans. So I'd recommend you start with $11k to IRA's and then worry about the remaining $39k/year.

Do you count the net worth as the value of the or the equity you have in it?

I use equity for net worth: the value of each home, minus the remaining mortgage and projected expenses associated with selling it, such as realtor fees and capital gains tax for the investment property.

[MooseOutFront]

I use a low-balled but realistic price I could sell my home for (minus transaction costs) vs what I owe on it.

[nawhite]

I use a low-balled but realistic price I could sell my home for (minus transaction costs) vs what I owe on it.

Same. And even with that I'm still at 45% real estate where I'd rather be 10%. Therefore, I invest (or pay down shitty student loans as the case may be)

[AlanStache]

yep is a good problem to have  :-)

I am in a similar boat but have a bit higher rate and decided now that I have 40k in a taxable account (and all tax advantaged being maxed) I am going to really up my over payments and try to get mortgage free in <5 years.  Remember 7-8% annual return is a historical long term average, is hard to really apply that to the next 3-5 years.  40k seemed like a good number, have no real math or logic to back it up.

I wrote a monte-carlo FIRE calculator/simulator and it showed a rather small benefit on average to investing more rather than paying a mortgage down.  Makes some sense since the percent difference we may be talking about is 2-4% on 100k over 3-5 years, it just does not have time to compound up, then it goes away.  Yes  4% on 100k for 5 years is ~21k but in the big picture how much you spend in an on going basis has a MUCH bigger effect on your FIRE date according to my m.c. simulator, no surprise to any long time reader here.   I would like to put some of the m.c. simulator up here but have not found the time to clean it up and make it presentable.

Short answer: I get the math behind more investing but one of the big points behind all this is to feel and be free and I think I will feel (and probably be) freer without a mortgage than an extra 10k net worth in 5 years.

[rpr]

I too used to think that for the long haul one should invest instead of paying off the mortgage. Recently, I have read a few articles on "The Retirement Cafe" blog which is making me rethink this. The fundamental problem that blog raises is the following:

Investing in the US stock market has an expected return of say 9% with a standard deviation of almost 18%. Now if you take a mortgage at 4% rate and then invest the proceedings in the stock market what happens is that your expected return drops to 5%, but the standard deviation remains the SAME at 18%. Thus your portfolio has become much riskier. I did know that borrowing to invest is risky but I appreciated the simple way in which that blog describes it. For those interested here are the links.

http://theretirementcafe.blogspot.com/2014/05/investing-mortgage.html

http://theretirementcafe.blogspot.com/2014/05/selling-stocks-to-pay-mortgage.html

http://theretirementcafe.blogspot.com/2014/05/you-should-pay-off-mortgage-right.html

My takeaway from reading those articles was: If you 1) do NOT have any issues with liquidity and have sufficient cash for short and long term needs AND 2) are saving enough for retirement by contributing fully to tax advantaged retirement accounts, THEN it is probably worthwhile to consider paying off your mortgage.

Unfortunately in my case, I fail the first condition given above :(