Money, investing, finance, and entrepreneurship are more than just a hobby for me — it’s a passion. I have a close friend, Chris, who shares very similar interests with me. If you see us together, chances are we’re talking about business, marketing, or similar.
The other day, he casually mentioned that he was paying $300/month extra on his mortgage just to “pay it off early”.
I couldn’t help but cringe a little.
Now, of course, not everyone sees things the same as I do. In fact, most people would applaud Chris for wanting to pay down his house quicker than 30 years. In our debt-ridden society, it’s a lofty goal to be 100% completely debt-free, and one that I highly endorse.
With one exception.
I’m a firm believer that you should never pay off your home early. Here’s why:
Your mortgage is some of the cheapest money you will ever borrow
If you’ve purchased a home within the last 5 years, chances are you have an interest rate somewhere in the range of 3-4%. While interest rates are starting to climb steadily as of late, historically, we’re still at a historic all-time low. In October 1981, mortgage rates hit a whopping 18%! As of this writing, interest rates are sitting right around 4.7%.
Almost every other type of debt I can think of has a higher interest rate than current mortgage rates. Federal Student Loans are generally in the 6-7% range. Credit Cards can range anywhere from 14-35%! And that’s assuming you have good credit.
Rather than paying down your mortgage, use the extra funds to pay off higher-interest debt. Don’t have any debt? Save for a rainy day, or invest it elsewhere (see my next point).
You could be earning more elsewhere
First, if you’re one of the lucky few Americans that has a few hundred dollars leftover at the end of the month, congratulations! It’s rare for people to have more paycheck left than month.
Rather than dumping the excess on your mortgage, invest it. Especially if you’re younger than 50. One of the greatest assets you have on your side is time.
In 2017, the S&P 500 rose a whopping 19%. Although this was an exceptionally good year for the stock market, most index funds typically see returns of 10-12%.
Keep your money in the stock market instead, letting it compound and earn dividends for you. Even after taking inflation into account, you’re still coming out much farther ahead than the 4% you’re pouring into your mortgage. (Keep in mind that inflation is right around the 2.0-2.5% mark.)
Mortgage interest is tax deductible
Every month, as you pay your mortgage payment, a certain amount goes to paying down your principal, and another portion goes to paying interest on your loan. If you’re still within the first 15 years of repayment on your loan, the majority of your mortgage payment goes towards interest.
At the end of the year, come tax time, all the money you paid in interest over the course of the year is deducted from your taxable income, lowering the amount of taxes you pay. This increases the likelihood that you’ll get a refund (or have to pay back less to Uncle Sam).
In 2017, the mortgage interest tax deducation was diminished slightly. The law was changed to beef up the standard deduction, meaning that less people itemize now. But if you do still itemize, you can deduct up to $750,000 of mortgage interest debt — nothing I would scoff at.
Personal tax dedications are few and far between. Throwing additional money at your mortgage gets rid of one of the few tax-related benefits as an individual.
Paying off your mortgage places all your eggs in one basket
There’s something to say about diversification.
If you fall into the under-40 category, you likely found your way here after reading advice on debt payoff. Looking at the mountain of debt before you, it’s natural to want to attack the largest debt you find yourself owing — your mortgage.
Odds are, dear reader, if you’ve been racking up debt before discovering personal finance, you likely don’t have too much in the way of assets. Paying off your mortgage is a concentrated bet on real estate (which I love, by the way). But it’s a concentrated gamble on residential real estate. Residential real estate in one specific town, in one specific neighborhood, with specific neighbors, with specific traffic patterns and shrubs in your front yard.
Catch my drift? Being house rich and investment poor isn’t the most ideal situation to find yourself in. There’s real value in liquidity and ensuring that should something catastrophic happen, your other investments could keep you afloat in the meantime.
Your 401k or IRA have more legal protection
Are you at risk of being sued? In our litigious society, if you have a pulse, the answer is yes.
A federal law known as the Employee Retirement Income Security Act of 1974 (ERISA) protects private employer retirement plans, such as your 401k and/or pension, against lawsuits. The only exception to this is in the event of divorce, your spouse could claim part.
IRAs are a slightly different game, as the law varies from state to state, but the general consensus is that “no”, IRAs aren’t counted and can’t be taken in the event of a lawsuit either.
Paying down your mortgage builds equity with each passing month. If a lawsuit is brought against you, lawyers can very easily pull up your list of assets and decide whether or not it’s worth their time to pursue. Should they find a large sum of money tied up in home equity, you can absolutely bet they’ll proceed.
Your money will be worth less in the future
Whenever you borrow money and have to pay it back later, it’s generally a good deal in the sense that you’re paying back creditors with devalued currency.
The $20, $200, or $200,000 that you agreed you’d pay back in the future is not worth as much as it is today. A dollar today is worth significantly more than it will be in the future. In fact, one dollar in today’s money will be worth less than fifty cents 25 years from now, given our current inflation rate of ~2.5%.
If a lender told you that you had to pay them back, but you could make payments with cheaper money, you’d be stupid not to take them up on it.
I guess I shouldn’t say to never pay off your mortgage. If you’re approaching retirement age, there’s definitely more of an incentive to do so. But even once you pay off your home, you’ll still always be burdened with property taxes and homeowners insurance. You’re never 100% free and clear.
I’m simply an advocate of having more diversification, and cash-flowing assets as opposed to all your eggs in one basket.
Happy investing, friends!