The case against paying off your mortgage!

by Krantcents · 57 comments

Post image for The case against paying off your mortgage!

Many personal finance experts suggest paying off your mortgage.  I realize that interest rates are very low on savings, but mortgage rates are historically low too.  If you itemize your income taxes, you can write off your mortgage interest and the government subsidizes your rate by giving you a tax deduction. The government is encouraging home ownership.  Why would you want to give that up?

If you pay off your mortgage, you have a debt free asset, but you cannot convert it to cash instantly.  I suppose you could have a line of credit secured by real estate.  I thought you wanted your mortgage paid off?  A line of credit is priced at a higher interest rate than a fifteen (15) year or thirty (30) year mortgage rate.  It usually starts at prime (3.25%) plus a margin based on your credit score.  Mortgage interest rates fluctuate by state or region, but it ranges from 2.5% to 3.5% depending on credit and terms.

Should you invest your money versus paying off your mortgage?  The year-to-date stock market performance for January ranges from a low of 4.06% (Nasdaq Composite) to a high of 7.22% (S&P MidCap 400).  Those returns may or may not continue for the rest of the year, but why would you pay down a loan that only costs you such a low interest rate?  If the stock market performs at historical (40+ years) averages, you will earn more by investing.  I realize there is more than dollars and cents that motivate people to pay off debt.

Real estate is a leveraged investment and financed at these historical low rates.  Real estate is starting to recover, although it is local.  In Los Angeles, there are multiple bids above the asking price with properties over $500K.  I realize that in other parts of the country, this would be a mansion, but this is not a mansion in Los Angeles.  In some areas of Los Angeles, property values are back to what they were before the real estate bubble burst.  If home values increase just five (5%) percent, you added $25K in equity for a $500K home.

If you own your home outright (no mortgage), you earned 5%.  If you have an eighty (80%) percent mortgage, your return on investment (ROI) is twenty-five (25%) percent.  In either case (mortgage or no mortgage), you can only realize your gain when you sell.  If it is your personal residence, you can exempt $250K as an individual or $500K as a couple from taxes.  This would not be true for your stock market investments, although you would only be subject to long term capital gains if you own the investment over one (1) year.

Final thoughts

I tried to raise enough issues to make you think about your investments.  I used real estate to build wealth by investing in rental property. Investing can be a personal residence, stocks, bonds or mutual funds. Yes, your home is an investment because it does appreciate in value despite what occurred in the last few years.  I am not telling you to not pay off your mortgage; however you should think about alternative investments before you do.  Many people would just sleep better at night when they have no debt.  What should you do?  Consult your tax professional before you pay off your mortgage!

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My Financial Independence Journey February 23, 2013 at 4:49 am

I agree that given the low rates, paying off your mortgage might not be the best way to go. But, I can also imagine a situation where paying off the mortgage early greatly decreases your annual expenses, thus reducing the amount of money that you need to have covered by passive income in order to hit financial independence. This is definitely something needs numbers run on it before decisions are made.

Krantcents February 23, 2013 at 8:27 am

Financial decisions are always individual and you may want to pay off a mortgage. I am simply approaching it from opportunity costs and what you can do with those cheap funds.

Michelle February 23, 2013 at 7:24 am

Right now we are not working towards paying extra on our mortgage since we plan on selling it within the next year. The next house though, we do want to pay it off ASAP.

Krantcents February 23, 2013 at 8:32 am

I never wanted to pay it off! All that changes when you are about to retire.

Lance @ Money Life and More February 23, 2013 at 7:46 am

The biggest thing in my mind with mortgage interest rates this low is inflation. If inflation averages 3% and you have a mortgage at 3.5% you’re only paying .5% interest in real terms.

Krantcents February 23, 2013 at 8:32 am

Historically, without inflation we haven’t seen these rates for 60+ years.

funancials February 23, 2013 at 8:35 am

Lance nailed it.

A combination of inflation and Time Value of Money says you shouldn’t be in a hurry to pay it off. Obviously, it’s never a bad thing to be “debt-free,” just as you know there are opportunity costs associated with it.

Krantcents February 23, 2013 at 9:27 am

The fact that the government subsidized mortgage rates with a interest deduction also lowers the rate. If you add inflation, you are paying just about zero. I like to keep my money working earning more money. I think it can be argued the other way too if home values keep going up. In the Los Angeles area, it is a seller’s market right now because of low inventory.

Grayson @ Debt Roundup February 23, 2013 at 7:47 am

This is something that I always look at. I have no desire to pay off my mortgage early. I make much more by investing.

Krantcents February 23, 2013 at 8:33 am

I agree! My only motivation now is retirement.

Holly@ClubThrifty February 23, 2013 at 9:25 am

Prepaying our mortgage is part of our early retirement plan. Of course, we are saving and investing in other ways at the same time. In the end, it’s a personal decision. I can see why both ways could be the right decision for different people. I am very debt averse and cannot wait to get rid of my mortgage ASAP! 31 months to go and I will be debt free at age 35. No regrets! =)

Krantcents February 23, 2013 at 9:31 am

It is an individual decision! My problem is not having access to a growing asset. I would never consider a reverse mortgage, but I still maintain a line of credit (zero balance ) on m home.

Tony@WeOnlyDoThisOnce February 23, 2013 at 2:19 pm

Totally hear what you are saying, but I am the kind of guy who sleeps better with no debt. It’s strange, but true!

Krantcents February 23, 2013 at 3:14 pm

Everything is individual and we all make choices for ourselves. My mortgage is less than the rent for my home and I will pay it off in just over 4 years from now. If I had consumer debt, I would feel completely different.

Daisy @ Young Finances February 23, 2013 at 2:42 pm

Mortgage rates are low now, but depending on the amount you have left to pay off, you may have to renew at a much higher rate in the future. Paying it off more quickly can help avoid uncertainty. However, depending on the investment as mentioned, it may be better to invest instead.

Krantcents February 23, 2013 at 3:17 pm

I view it as opportunity costs! My mortgage interest rate is currently 5%, but I have accelerated the payments to pay it off in a little over 4 more years. Between that and the IRS treatment of interest, it is jsut a little more than inflation. The net interest is close to zero. If I cannot earn more, I should pay it off faster.

Holly@ClubThrifty February 24, 2013 at 11:47 am

Have you thought of doing a no cost refi?

We just refinanced ours again through Amerisave. Amerisave offers enough lender credits for certain loans to make them truly “no cost.” They will pay all of your closer costs in exchange for you paying a higher interest rate. In our case, the higher interest rate we settled on was 3.25% (since 15 year loans are at 2.75%) My next Get Rich Slowly story is about the refinance. You might look into it! All I had to bring to closing was my amount of money needed for escrow. Then my old loan closed out and I was refunded the escrow balance. I actually came out ahead $40 somehow.

Krantcents February 24, 2013 at 12:55 pm

My balance is too small to refinance! I checked with a mortgage broker and she said my best alternative is to just repay the loan faster and I will achieve a similar low interest rate.

Holly@ClubThrifty February 24, 2013 at 3:48 pm

Gotcha! Well, good for you then =) I’m jealous! This refinance will be our last. I cannot wait to have it all paid off!~

Elizabeth @ Broke Professionals February 23, 2013 at 5:06 pm

There are so many shades of grey to this argument – there are situations where it makes sense, and situations where it doesn’t. It’s an example of where there’s no one size fits all solution.

Krantcents February 23, 2013 at 7:36 pm

I see it as an individual choice. It is not right or wrong to pay off a mortgage. I was just trying to raise questions to create a conversation. I see it as opportunity costs, if you can earn more money with your money you should invest, if not pay off your mortgage. One solution may be having a line of credit on your equity so you have access. I would only do this if you handle your finances very responsibly, although it would be at a higher interest rate.

Canadianbudgetbinder February 23, 2013 at 5:08 pm

I’m with Tony and I just will sleep better knowing we have $0 in debt. We will pay ours in full in the next month or so once the paperwork is completed. We are only just in our 30’s so that gives us ample time to continue to invest in our retirement like we have over the years. Personal, sure.. that’s all it is. Cheers, good read

Krantcents February 23, 2013 at 7:40 pm

I think it is always an individual choice! I will pay off my mortgage in about 4.5 years when I retire (again). I will keep a line of credit tied to my residence to have access to the value. With values in southern California so high, I do not want to leave that much money tied up.

KK @ Student Debt Survivor February 23, 2013 at 6:39 pm

Bf and I have been seriously considering purchasing a rental property (instead of putting that extra money into our own mortgage). My mother thinks we’re nuts. But I think it really depends on the individual and how “risky” they perceive having more debt. I don’t think of mortgage debt as “bad debt” and taking out another mortgage isn’t scary to me. For my mom it’s terrifying because she was taught to buy a house and pay it down fast.

Krantcents February 23, 2013 at 7:53 pm

The good news is in this low interest environment, you should be able to find a a home that will have a positive cash flow. It is all a matter of perspective! I think you should always approach it conservatively because of the unknowns. Make sure the numbers make sense.

mbhunter February 23, 2013 at 7:14 pm

Yeah, locking in current rates for 30 years is a great deal. There isn’t much place for rates to go but up. Plus, there’s inflation. Your mortgage payment will buy a pizza by the time it’s due.

Krantcents February 23, 2013 at 7:55 pm

For years, my payment is less than the equivalent rent for my home. When we downsized 15 years ago, I made sure to lower our expenses. It was part of my plan to prepare for retirement (again). I am still holding on to my line of credit so I can access the value of my asset.

Lisa @ Lisa the Vegetarian February 24, 2013 at 6:59 am

This is a very interesting perspective, and one I can’t say I’ve heard much of before. I’m going to be buying my first house this year (hopefully), so I’ll have to keep all aspects of the journey in mind.

Krantcents February 24, 2013 at 7:45 am

I would like to think it is my unique view of personal finance that makes it worthwhile to read my articles! 🙂 My approach comes from many years in business and multiple careers. The net interest for mortgages is almost zero, it just makes sense to consider alternatives to paying it off.

Pinyo February 24, 2013 at 8:26 am

I agree with you. As of this past Friday we broke $1 million mark in mortgage debt. This probably feels wrong to a lot of people, but we feel like we are doing a great thing for our finances. We now have multiple houses appreciating and generating income.

Krantcents February 24, 2013 at 9:47 am

One of advantages of rental property is increasing asset value as the tenants are paying your mortgage. The income is not bad either. Congratulations

Miss T @ Prairie Eco-Thrifter February 24, 2013 at 3:07 pm

Good post. This is always a good topic. I think you have to weigh the interest gains and losses. Where are you going to come out more ahead. That is the one you go with.

Krantcents February 24, 2013 at 7:32 pm

I agree wholeheartedly! It is called opportunity costs. If you cannot earn more money elsewhere, you should pay down your mortgage! I realize it is more than just the numbers, but I think you should always run the numbers and do what is right for you.

101 Centavos February 24, 2013 at 5:38 pm

Given the low cost of money, *not* paying off the house is a viable strategy for us. In any case, unlikely that we’ll stay in this house in the next fifteen years.

Krantcents February 24, 2013 at 7:08 pm

In reality, I am sitting on an asset of somewhere from $500-1MM depending on timing and cannot access the cash unless I borrow against it. I realize it is appreciating, but I lost my leverage and the money is tied up. In my case, my mortgage payment is less than the rent equivalent.

Brick By Brick Investing | Marvin February 24, 2013 at 6:11 pm

I applaud you for taking on such a highly debatable topic in the personal finance realm. Great article and points, as always I believe it depends on the individuals situation. I can definitely see your point of low interest rates and writing off the mortgage interest. However, some individuals may not have steady jobs or as you pointed out would like the burden of debt lifted off their shoulders. With this hot topic I rarely give a blanket answer, it always depends on the situation.

Krantcents February 24, 2013 at 7:12 pm

I agree it is a very individual decision, but you have to consider what I wrote even if you dismiss it. It is called opportunity costs! I understand your point because I have professional comedians who bought their house for cash years ago because of the very nature of their career. I think a lot of people can relate to their situation.

The Happy Homeowner February 25, 2013 at 12:57 pm

I agree with you about this–it’s why I’m in no rush to pay off the rest of my student loans because they’re locked for life at 1.265%. My money works far better for me in other investing avenues. I’m also working to buy an investment property, so I’m all about making sure I get the best return I can.

That being said, I do understand that some people just want/need to free up more cash in their monthly budget. Paying off such a large debt can do that–but you have to get through the years where you sacrifice to make those extra payments.

Krantcents February 25, 2013 at 1:37 pm

I realize housing is generally your biggest expense, but generally at the lowest interest rate. I think it is much wiser to buy a home that fits well with your other expenses. For example, we downsized 15 years ago. My mortgage payment was cut in half and so were the monthly expenses related to my home. I realize it is an old rule of thumb, but your rent should not exceed your weekly wage and a mortgage payment should be similar. It is no easy task in southern California.

Buck Inspire February 25, 2013 at 11:44 pm

This post hit home as I recently purchased a new house. Great point about looking for alternative investments. The stock market does have better historical returns, but with the recent volatility, sometimes safe is better than sorry. Chalk this up to individual risk tolerance. Thanks!

Krantcents February 26, 2013 at 6:55 am

It is always individual choice, but it is worth considering.

Leslie February 26, 2013 at 12:06 pm

I agree with your strategy in general. I’ve been using my home for investment capitol for many years. But, I’m getting closer to my rental goals and OLD AGE so I plan to use a “hybrid” from here on out: pay off the mortgage soon and then get a maxxed out equity line for emergencies or quick cash for a sweet deal. Good information, thanks!

Krantcents February 26, 2013 at 1:07 pm

Good! Remember to use that line of credit responsibly or your load it with debt.

AverageJoe February 26, 2013 at 5:07 pm

I love the people who say, “I sleep better with no debt.” Do you sleep better with less retirement money? Do you sleep better if you aren’t going to reach your goals?

Often people make blanket statements without analyzing their whole situation. If the choice was between having the flexibility to retire and paying your house off, I think most would choose the flexibility rather than working forever in a paid off house.

I think this is my favorite article of the many, many I’ve read of yours, KC. Thanks!

Krantcents February 26, 2013 at 5:23 pm

Thank you, that is high praise! Funny, I have always thought this way, but the low interest rates make it obvious. To me, it is opportunity costs if I can earn more elsewhere why not?

Jay Castillo March 3, 2013 at 9:42 pm

If the goal is to make the most of your money, and mortgage rates are significantly lower than what you might get with stocks, then I guess it’s worth the time and effort to at least sit down and do some number crunching.

Most people however would rather do without the stigma of having a debt and monthly mortgage payments, which is very understandable. I’ve had that same desire to payoff my home loans before, even if they were for properties that I consider to be good investments, and I must admit that it really felt good when I did pay them off.

Krantcents March 4, 2013 at 6:56 am

When did a mortgage become a stigma? I hope my article adds to the discussion.

Kim@Eyesonthedollar March 4, 2013 at 4:24 pm

I used to agree with you, and I see the logic of keeping a mortgage at a low rate, but I just want debt gone. Then we will have the money to invest in really whatever we want. After watching my in-laws go through foreclosure, I never want anyone to be able to take my house away. Irrational or not, I want it paid off.

Krantcents March 4, 2013 at 5:08 pm

It is not irrational for you. Although I will pay off my mortgage for retirement, I view it similar to rent. My payment is actually less than rent for my home.

Krantcents February 25, 2013 at 5:55 pm

Don’t be jealous, you should expect it with someone my age! As they say, I walk the talk!

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