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MY SON AND HIS fiancée recently purchased their first home. They’ve asked me about things like how to fix a leaky faucet, but they haven’t asked me for financial advice—which is a good thing, because I’ve had very limited experience buying houses.
You see, my wife and I bought our first and only home in 1986. We paid $89,000, putting down $20,000 and taking out a $72,000 mortgage by the time we added in points, fees, taxes and the myriad other costs associated with a loan closing. Our interest rate was 8.5%.
We knew that we wanted to pay off the house early, so we started making extra principal payments. We also refinanced our mortgage twice as rates dropped. The upshot: We paid off the mortgage in 11 years.
But were we financially smart to do so? Remember, this was at the beginning of a long bull market. By paying the mortgage off early, we avoided some $88,000 in interest payments over what would have been the full life of the mortgage. That’s before factoring in the tax deduction for mortgage interest. If you figure that in, the savings might have been $65,000.
Had we had taken the $231.32 per month in extra principal we were paying on our mortgage—equal to more than $30,000 over 11 years—and instead directed it into the S&P 500, that $30,000 would have grown to $75,000 over the course of those 11 years. Throw in perhaps another $8,000 in dividends, and our $30,000 would have been worth $83,000 before taxes, and the sum would have continued to grow from there.
Or, to put it another way, the 8.5% interest rate we avoided, which was even less after our two refinancings, was well below the return we could have earned in the stock market. To be sure, investing in stocks is considerably riskier than avoiding interest by paying down a mortgage. Still, we clearly left money on the table.
So was it a good idea to pay off our mortgage early?
About two months before we made our last payment, the Fortune 500 company I was working for spun off 13% of its employees into a different corporate entity. Many of those employees subsequently lost their jobs.
A manager that I knew—who was making much more than I was as a junior engineer—confided to me that, if he lost his job, he only had about two months of living expenses saved. After that, he would be broke. He wouldn’t have just emptied his emergency fund, but literally he wouldn’t have any money to pay the bills.
Having a nearly fully paid off house gave us a tremendous psychological sense of well-being. My wife and I had also been frugal in other areas of our financial life, and we had both investment accounts and an emergency fund that would have allowed us to weather a long period of unemployment before we would come anywhere close to losing our home. I might lose my job. But I wasn’t going to be homeless, and we weren’t going to have to move and disrupt our children’s education.
So, if my son asked me if he should pay off his house early, what would I tell him? Make sure you have six months of living expenses in a very liquid form, such as a savings account or a money market fund. Make sure you’re contributing at least 10% of your salary to your employer’s 401(k), or more if that’s necessary to get the full employer match.
If you’re doing those two things, feel free to make extra principal payments with an eye to retiring your mortgage early. I have no idea what the stock market will do over the next 30 years. I do know that my son’s paying a historically low interest rate on his mortgage. Still, while I can’t place a dollar value on it, I know the peace of mind that comes from being mortgage-free—and he may be enormously grateful when the next economic downturn comes around.
Kenyon Sayler is a mechanical engineer at an international industrial firm. He and his wife Lisa are extraordinarily proud of their two adult sons. He enjoys walking his dog, traveling, reading and gardening.
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“myriad other costs associated with a loan closing.” I don’t know about those. My wife and I bought our first and only house in 1994 for $340K with $250K down and a $90K mortgage. (Housing is expensive in Honolulu.) The reason I don’t know about those other costs is that we didn’t go through a bank. I figured the monthly mortgage payments myself, and I didn’t know about extra costs. Apparently, my self-designed mortgage was good enough, since the seller accepted it, and we did pay him the $900+/month, and now the house is ours since 2004.
I never tried to compare where our money would earn the best returns; instead I was concerned with rent during retirement. What sent us into the housing market at all was our landlord telling us that in 1994 he was raising our rent for our little cottage from $800 to $1000/month. Ouch! It would be a bleak retirement if all our income went to paying rent. So I decided, we had to buy.
Indeed, local rents have gone up substantially. So I think I was right about that. Also, though we didn’t buy our house as an investment, it’s now valued at about $1M. So it’s worked out well for us.
Have you ever spoken with anyone who paid off their mortgage and regrets it?
I haven’t. Without exception, every single person I’ve met without a mortgage is satisified with their decision and would do it again. The decision was rarely based on financial math. Instead, pretty much everyone talks about peace of mind and the personal satisfaction of not having any consumer debt. My only qualifier to accelerating mortgage payments or making a lump sum payoff is having enough cashflow and/or assets to support yourself in the future.
Great and intriguing analysis, and I’d like to offer a comment regarding “clearly left money on the table”. Sure… in retrospect. I wonder what the comparison would look like versus a historical rate of return (I’m guessing 5-6%) in the market post-depression (don’t quote me on that). I absolutely am with your thinking regarding “peace of mind”, but suppose that really is an individual thing. Regarding your son and his house, the historical low rates are a reason that I’m not paying down my existing mortgage. Yes, the market has been comical these past few years and it looks like a good ‘bet’ now, but I understand things can change like GameStop and likewise I suppose (unlikely) the situation with my housing could change as well. So for me my current piece of mind comes from paying a relatively low monthly mortgage and investing aggressively, together maintaining a decent degree of flexibility. Thanks!
I also have a very low mortgage rate and am not paying it off early. Most folks who say they want to use extra funds to invest in equities instead of paying down their mortgage early don’t actually invest that extra money. They use it for other things (nicer cars, better vacations, etc).
I paid off my house vs putting more money into investments. I can tell you during covid while I watched the markets and economy suffer, there was a calming feeling knowing that my home was mine.
I share your feeling from a relative point of view, but no one in the US owns their home beyond words on paper because all states levy property taxes. IMO, we are renting property from government ℅ these taxes and like any rental, non-payment will have you evicted. The memos on my property tax payments state Rent for XXXX (year) in weak protest.
While your strategy is all fine and good(one which I used), it is meaningless in the long run if you do not protect yourself with an appropriate level of life insurance on both parents. If one spouse passes away much earlier than expected your fine strategy is sorely impacted in a way that washes away any benefits that you feel you accrued. Your ability to maintain that house will be greatly impacted. Knowing a very young couple who was impacted by the loss of a spouse impressed on me the need of a more coordinated financial strategy. Tactics like the one you employed are fine but an overall financial strategy is the only way to at least have a chance at long run success in maintaining that home without even being able to adjust for things like job loss, job inconsistency, health, divorce, alimony etc.
While I don’t mean to dispute the noted benefits of being debt-free, I think the calculations here are imperfect; the prudent mortgage holder would not have maintained an 8.5% mortgage for the 30 year duration, but would have refinanced multiple times and significantly reduced the total interest the Mr. Sayler calculates. In terms of giving advice to his son, Mr. Sayler might note that the prospect of a 2.5% 30 year mortgage, in comparison to 30 years of likely future stock returns, is an entirely different prospect than if rates were 8.5%. I believe that young buyers today would be foolish to overpay their mortgage; it would be a decision similar to maintaining an oversized fixed income weighting in a young person’s retirement accounts.
You might want to double check on your state’s level of equity protection in case someone obtains a judgement against you in a lawsuit. In Colorado it was only $60,000 the last time I checked. In Texas it used to be $1,000,000, and Florida had an unlimited homestead exemption. A low interest mortgage may be safer than a paid off home.
I am not so sure “you left money on the table.” Pre-tax, you saved
$88,000 in interest by paying off your mortgage early. You say the
extra principal payments, had you invested them, would have grown to $83,000 pre-tax. Sounds like pretty much a draw, with a slight
advantage to paying off your mortgage. You are absolutely correct that
there is great peace of mind with having no rent or mortgage to pay each month.
Many an investment strategy calls for holding a portion in bonds. We can easily think of a personal home mortgage as a reverse bond. Therefore a mortgage directly reduces the equivalent % of the portfolio dedicated to holding debt and receiving those regular payments. If someone with a mortgage needs a certain % of their investments in debt instruments, even 0%, the same person without a mortgage needs a lesser %. I loan my adult child money as a mortgage, and this is the main portion of my portfolio in debt instruments. I am glad to have it, as it is a good deal for me and a great deal for them. I encourage them to pay it down quickly. They also invest, primarily in tax advantaged accounts. I did also lower their interest rate to reflect the depressed bond markets.
I followed a similar strategy which got me out of debt in 10 years. Financially, it worked well, but my real reason was that I really hate being in debt. Instead of making extra mortgage payments, I made a large down payment, to reduce the size of the mortgage.