Ben Stein: Invest or Pay Off Mortgage?
This is an age-old question. Does it make more financial sense to pay off your mortgage quicker by increasing or adding payments, or to use that extra money and invest in an index fund in the stock market? The simple answer is to choose the option that leaves you with the most money down the road, and with low mortgage rates, the better choice is investing for the long term.
But that’s a simple answer to a complex question. There is a psychological aspect of money that differs for each person. Money isn’t all about math for most individuals. Some are good at separating emotion from money and treating their finances as a business with little emotional attachment, but that’s not common in my experience. For some people, eliminating debt is preferred over maximizing money. For one, less or no debt can reduce stress, which improves your health.
Nevertheless, Ben Stein agrees with my opinion on the matter:
Generally speaking, if you have a very low mortgage rate, it is better to invest the money than to pay off your mortgage. It’s an interesting fact — the rate of return on your mortgage is the interest you’re paying on it. If you have a 6 percent mortgage and you’re paying it off, you’re earning 6 percent. If you can earn more than 6 percent in the stock market, you should probably put it in the stock market. But, on the other hand, pay it off in an expeditious way. It’s good to have it paid off, or at least mostly paid off, by retirement time.
This simplified answer doesn’t take into account the emotional side of money. Perhaps it shouldn’t because facts are facts (unless they’re statistics). But it also doesn’t mention tax benefits of a mortgage for those who itemize their deductions (the home mortgage interest tax deduction) and it doesn’t take into account variations in stock market returns depending on your chosen investments and on market cycles.
His last point is the important one, I think. Once you retire and income presumably drops, you don’t want to have that much of a mortgage payment preventing you from using your money for other living or enjoyment expenses.
Article comments
We owe only $16,000 on our house. Should we take stock out and pay it off? My husband retires in 3 years and we want to build a lake house. If we pay our house off now we could save for our lake house. Is there a penalty for cashing in stock? We live in Alabama.
Paying off your mortgage ties up your money in a non-liquid asset that then ceases the “returns” of your after-tax interest deductions. Sure, you may stop paying the 6% interest on your mortgage, but the bank doesn’t start paying you 6% of your house value afterward! Investing your extra cash instead will yield liquid returns that continue compounding well after the end of your mortgage (which becomes less costly over time due to inflation – think of your parents who bought houses for amounts that sound like pennies in today’s dollars), not to mention you’ll have that money available to continue paying bills should you lose your job or have a financial crisis. And let’s not forget, you’ll always have bills… just because one is called “mortgage”, that doesn’t mean it’s a special bill that sucks worse than electricity and gas and food and property taxes and car payments etc etc etc.
In a similar situation as the rest. 48yo business owner. Wife does not work, and one through college and two on the way (529 plans in place). We currently have a retirement plan though the business (simple plan) and contribute monthly a nominal amount. I owe 235K on my home that currently has a mortgage rate of 4.25% and is on year 5 of a 15 year note. I have been paying additional principal each month for a while now. The business I am part owner in has a line of credit at about 5.5%. The business owners keep some equity in the business to reduce borrowing. I am wondering if I was to take enough distribution (taxes already paid) from the company to pay off the mortgage, or should I take that same 235K distribution and put it in a retirement / investment account?
Are you seriously suggesting that people play in the market rather than pay off their mortgage? You’ve never worked years to pay off your (or your spouse’s) undergrad/grad school loans. Neither have you ever put your kids thru college debt-free. If you had, you’d realize that you want to pay that frickin mortgage off asap.. Screw the market – it bounces up and down. PAY THE DAMN MORTGAGE OFF ASAP.
I have been out of school for 10 years and have been blessed with a financial planner who has invested wisely and brought me good gains. My wife and I are feeling like we should change our focus from wealth accumulation to debt reduction. If I cashed out my investments I could nearly pay off my 220,000 remaining mortgage.
Considering that the market is at a high right now and that it may soon see big losses if the government fails to correct our nations financial struggles, would it be totally crazy to cash out, pay off my mortgage, then start investing heavily again. Wouldn’t that really work out to my favor if the market drops a lot after I cash out and then I re-invest in a low market. Sell high, buy low philosophy. Thanks
Tyson,
Every financial planner will tell you not to cash in your investments to pay off the mortgage for a gazillion different reasons (some valid, some not). If I were you and those investments were NOT retirement investments, I’d pay off that mortgage in a frickin heartbeat. If, however, those investments are all tied up in retirement accounts you probably should not do that and in many cases, even if you wanted to cash out your retirement investments, you can’t. I’ve got a 401a and a 457 that I would love to withdraw from to pay off our mortgage, only I can’t because of the tax law. It frankly p###es me off – but those are the rules. We’ve lost our butts HUGELY 2 times now and I know the 3rd time is just around the corner. It’s going to make me sick when the next “correction”, i.e. CRASH takes 1/2 our portfolios, particularly when we could have paid our mortgage off completely with just a fraction of that.
If you investing in the stock market is such a better deal than mortgage payoff why aren’t we refinancing with a cash out mortgage investing that into the market?
-Nick
because then the question is whether investing in the stock market is better than investing in one piece of real estate (your home). It’s a valid question, just not what’s being considered in this particular article.
I have asked myself this same question and made an excel spread sheet to see which way I would end up with the most money. Every time I look at it, it always comes out the same in that it is better to pay the mortgage off first and then invest the rest.. For example if you have a 30 year mortgage. So if you pay extra money down towards the mortgage and pay it off in 15 years, then keep put the same amount of money that you were towards your mortgage now to investments for the next 15 years. This was taking into account the tax you would have to pay on investments, and tax deductions you get from the interest paid on mortgage.
Yes you are loosing the interest that you would have made over the 30 year period, but also the principle is less since thousands of dollars were given every year to the bank which is money that you will not get back. So in the example above you will have slightly less total interest earned, but a larger total amount of money saved since it was not given to the bank to pay the loan interest. It seems about the break even point is if you can get 15% or higher on your investments, then it is better to pay extra towards investments.
Retired granny raising grandchildren.. Paying off 5.75% mortgage as my overall investments pay about 3% total. I also live off the investments + just 300.00 mo. from IRA. So they are depeting rapidly. No one has addressed the taxes and insurance that will continue to be required regardless of when mortgage is paid. SO now w/ investment company calling all my bonds by end of year – do I finish paying off the mortgage and cut expenses even more OR reinvest that $$.
I have $27000 in the bank $41000 left on a 100k mortgage. 5.375% I pay an extra $521.21 on my mortgage. SHould I pay off my mortgage before I get married again? If I don’t pay it off will it become community property??!!??
It will become community property anyway.. If that is really how you think then you’re missing the point of ‘marriage’ and probably shouldn’t be getting married again….
What about factoring in the amount charged for the initial investment by the broker? Also, if I can add $1350 a month to my mortgage I will save and extra $32475.47 over 97 months vs. what I am currently paying, saving me $334.80 per month which works out to be about a 25% return on my investment with no risk These numbers suggest that I pay off my mortgage. Does anyone suggest otherwise. Brokers tell me to invest, but they profit from that and there is risk. Banks tell me not to pay off my mortgage, but they profit from that. If a stock fails, you have nothing. If the housing market fails, you still have your house. This is my simple way to look at it so I’m asking for suggestions please.
I have noticed that no one has mentioned here how assets figure into student-aid calculations for college. I understand that some institutions do not count equity in your home as part of your assets so if you have college-bound kids, that would figure into your decision about whether to pay off your mtge.
does anyone have a handle on this? I am looking for a straight answer so I can figure out what to do.
I think we will deflate then hyperinflate.
So, IF the SHTF and your house is paid off you can stay there instead of a cardboard box with a 401K or IRA that lost all it’s value.
But IF you can keep a job and they hyperinflate it would be nice to pay off the house with depreciated dollars. The dow would probably skyrocket since it is based on dollars and those will be worthless, essentually you will have the same more or less.
What I think is going to happen is the banks are going to have to reel in their investment hedges thus collapsing the economy, first one out wins.
Hold tangable assets, that is why the central banks are secretly moving towards the exits and grabing gold.
One thing that I rarely see mentioned in these “pay off mortgage or invest” scenarios is the relative risk involved.
Paying off a mortgage has very low risk. The equivalent risk in investing would be an FDIC insured bank account, which is going to pay very little interest in comparison.
Today (2011) you can get mortgages aroudn 4%. To get the equivalent return in investing, you would have to go to very, very long term bonds (30 years) in a company that has a lower credit rating than U.S. treasuries. This introduces interest rate risk and return of principal risk. This is higher risk than paying off your mortgage, and all it does is match the return of paying off your mortgage.
The next option is stocks. You could get a higher return than 4%, or you could lose a substantial amount of money. You must factor risk into the equation. On average, returns in stocks are 7%, not 10% commonly quoted. And you greatly increase your risk.
Here’s another way of looking at the same situation. You are nearing retirement and your house is paid off. Should you mortgage the house for full value so you can invest the money in the stock market? If you are scoffing at that idea . . . you know what you should be doing.
And to Chris, you didn’t complete the analysis. You only looked at the difference over the first 17 years. But after the mortgage is paid off, you have much more money to put towards investments. You’ll find that you will quickly catch up, and with much lower risk. Much greater peace of mind.
Regards, Everyone.
We just bought a $287.500 1BD CoOp and put down 20% ($57.500.00) fir which I used $28,750.00 in cash savings and took a $29.000.00 401K loan. We got a 4.25% fixed mortgage rate on the $230.000.00. Are we better off making addtl mortgage payments or, investing surplus in mutual funds? I am 51 and suppose I’ll be working for 20 yrs. more to pay mortgage. Also, I have 15 years to pay for the 401K loan which scares me more if I ever lose my job. There are no penalties for paying either mortgage or 401k loan sooner.
Thanks Alfie
After reading all your questions and suggestions, I decides to pay off my mortgage. With debt free, you will have lots of more options to be who you want to be like job you like but pay less. More saving or investing…etc
Hello everyone,
I am a single 53 year old female with a 13 year old daughter still at home. My Mother passed away recently and I inherited a little over one hundred thousand dollars. My mortage payoff is 41,000.00 and I have a second that is 14,000.00. My Lutheran Brotherhood rep tells me to invest all of it and to not pay off my mortage since I only have seven more years on the loan at 5% interest. My gutt tells me that I should pay off my mortgage and my second to be totally debt free. Any thoughts would be greatly appreciated.
Thank you,
Pam
Your gut is probably on the right track. This allows you a mortgage-free life and is an excellent way to honor you mother. You are the only one with a vested interest in your money, so why listen to anyone who would lose nothing if you lost it in the market. If the almighty gave you a financial consultation what would he(or she) say? Probably pay off what you owe first above everything!! The rich man gets richer by you keeping your mortgage open and when you invest it with him- he doesn’t need anymore help than we’ve all given him. A lot of people focus on numbers which are pretty much the “smoke and mirrors” of the con that the rich are playing on all of us. Keep in mind that you owe nothing on your mortgage compared to most and you have a great opportunity that most never get…. -from a lowly barkeep
Pam,
One way to look at this is to see whether you can make 5% TAX FREE in the stock market/ bond market/ etc. If it was 2008- then you would want to invest it ALL, as the market was dirt cheap. But the market is up a great deal now. When you pay off the mortgage early- you are basically making whatever percentage the mortgage loan has on it (Not really- it is a little lower due to mortgage deduction). I also have a 5.5% mortgage, and I am paying it off “aggressively”. I cannot earn that much in my bond investments, so I am “plowing” it into the mortgage. Should be done in less than one year. The stock market is fully valued now, I’d be careful about putting all the money into it at once. I would suggest pay off the mortgages, then take the remaining money and set up an “emergency fund” FIRST if you don’t have one (6 months income ideally). Then start gradually investing the rest in a mix of stock mutual funds and bond mutual funds. The key is “gradually”, invest say 10-20% every three months in a stock index fund and a bond index fund. Choose a percentage for stocks you are comfortable with- I would suggest 50-60% (based on your age) and the rest in bonds, with 5% in REITS (real estate investment trust stocks). Go with “no load” mutual funds that have low fees. I personally like Vanguard mutual funds- I have accumulated enough to fully retire this past year at age 54 in them, but that is based on diligent saving since age 16! One way to think about fees is that is money that is taken “right out of your pocket”. Bonds are expensive and rates will head up sooner or later (bonds will drop when they do) and stocks are also “fully valued” in my opinion. By investing gradually, you avoid investing one chunk and then seeing it drop 30-40% due to a significant downdraft in the market. And whatever you do- keep the money invested in stocks. So many of my friends abandoned ship in 2008-2009. Not me I kept plowing as much as I could into the market and it paid off (even though it was hard to do it some days). Another option- consider using some of the remainder (after the mortgages are paid off) to fund a 529 plan for your daughter, it is a college savings plan. If your state has one, you can usually deduct contributions on your state taxes to help her get a college fund started. One other tip, when the mortgages are paid off- DO NOT spend that money. If you can keep investing the equivalent of your mortgage payment in long term savings (mix of stocks/ bonds) you will be in much better shape in 10-15 years. I have done it (even though my wife wanted to spend it) and now I “choose” to work, as opposed to having to work. Basically now the money I make will probably be inherited by my children (lucky dogs, hope they appreciate it!!!). It’s a nice feeling. Good luck, and also sorry for the loss of your mother.
Also, I DO NOT work for Vanguard, just like their mutual funds. There also is a good book to read about finances/ savings- Called the “Bogleheads Guide to Investing”. I would recommend it highly!
Here are my two cents, which I do not see stated in this blog.
1.) I say hammer on the mortgage until it’s 1/2 paid off. Why? You can easily knock off several months with $5000, especially just starting a 30 mortgage. After a while, the same amount doesn’t knock as many months off. So lop the top off your mortgage, then forget about it.
2.) Stay in the same house. Transaction costs are killers when buying/selling a house.
3.) Don’t marry a crazy women. This is a tough one to accomplish.
4.) Ensure your wife works and makes good cash. This is key. Remember, if she stays at home doing nothing for several years, then when you get divorced, you have to pay her for being so useless all that time.
5.) Find a partener who respects a dollar, not someone who’s spending out of control. You can figure this out on the first few encounters.
6.) Be suspect of people assuming a12% return on a investment. This past decade wasn’t nearly that amazing, not even close. But I do believe Wall Street white collar crime is a winner.
7.) Consider all costs when making a purchase. It’s always the extras that get you.
8.) Don’t trust anyone. Well, maybe your granny.
My wife doesn’t stay at home and do “nothing”. She works extremely hard as a stay-at-home mom. Personaly, I don’t think there is anything or any job more important or noble than that of a mother.
As to the question of the day. I say pay off the mortgage. No debt guaranteed financial security. The stock market might have a higher return but past performance is no guarantee of future results.
Okay, let me revise my comment from ‘doing nothing’ to ‘earning nothing’. My apologies to your wife.
However, take a common scenario, divorce after 10 years of marriage. You as a the single income earner are on the hook for a large portion of your income, for many years. Also, living expenses rise since the couple is now living apart. Additionally, the female’s skills are now outdated making it very difficult to get anything but a low paying job. So for the sake of both parties and your finances in general, have her work as soon as is reasonable. Part time, contract, whatever it takes.
I was a stay-at-home mom for 20 years to four kids. I also did all of our finances, home remodeling, and investing. When I discovered my husband had been cheating our entire marriage, just after I had hurt my back and become bed-ridden, I had back surgery, got a job, and bought my own house – all in a year. I did take half the assets (we would have had none if it weren’t for my investing and frugal budgeting) and a small amount for child support for five years. I left a very substantial amount of alimony on the table because I didn’t want to be tied to him. I earn 1/8 of what my ex makes and couldn’t be happier. I maxed out my Roth IRA last year and contribute 6% of my income to my 401K. I will max my Roth IRA again this year and increase my 401K contribution. I also want to pay down my mortgage. It’s my only debt and I want to get rid of it. Not all women are awful – I would still be married if my ex had been good to me.
Let me make this real simple for those thinking it is better to invest in stocks rather than pay off your mortgage early:
Would you take out a SECOND mortgage at 5% interest just to take that money and invest in stocks? A THIRD? Why not a FOURTH while you’re at it?
If yes, get as much “low interest” debt as possible and gamble in the market. If no, pay off the house!
Hey Flexo, great insight – though I have to come at this from a different angle. I don’t think most people buy a home with a return in mind, but rather for the security and independence provided through home ownership. I’m certainly not arguing your logic on which option provides a better return – in truth, I think you’re far over-estimating the return on a home (for instance, most first-time buyers don’t pay enough interest to warrant itemizing, so even the tax advantage is moot). Rather, my point is that home ownership evokes more than return – there’s an emotional attachment, a personal committment, and a sense of pride and accomplishment in owning your home outright that you just don’t get from investments. If return was the primary motivator, one could make a strong argument that renting and investing is a much better deal than buying a home.
Can anyone give me advice on this?
I have a mortgage of $171,000 (28 yrs left to [email protected] 4.7% interest). Should I pay it off now using $300,000 in assets from cash, IRAs and annuities or keep making monthly payments of $1,412? I am 63 and retired and my wife is 60 and will retire in two years. Our pensions and Social Security will give us a pre-taxed monthly income of $8,100 with about $6,000 in expenses per month. We did not plan to use this $300,000 for monthly living needs.
If you have $300,000 that you do not need to live off of pay that mortgage off yesterday. Your pensions/SS sound like they’re more than adequate for your needs. Lose the mortgage – gain the freedom and peace of mind being totally debt-free.
Can anyone give me an advice
I am planning to refinance my house (125K) for 10 or 15years. If I do it for 15 years I will have about 300/month for investment compare to 10 years. I can invest this money in 4% guaranteed insurance cash accumulation fund and get advantage of compounded interest. My mortgage rate is also 4%. Does it makes sense ? I have 17years before retirement. Need extra money for child’s college in 10 years.
It’s better to pay off your mortgage. By paying off your mortgage you get a guaranteed return of 6 percent on your money. With stocks you have to pay taxes which diminishes your return rate. Earning 8 percent Before Taxes is the same as earning 6 percent on your mortgage if you are in the 25 percentile tax bracket.
The stock market or the S&P 500 went down -37.22% in 2008, which will take many years to recover from. The stock market is unpredictable so paying off your mortgage is a safe bet.
Lots of good comments.
My situation in August 2010 will be debt free minus a $135,000 first at 4% interest. And a $89,000 2nd at 4% interest.
I will have $3500 a month extra to use to invest or pay off the mortgage and 2nd.
My thoughts were to
1) After all debts are payed, I plan on saving the 6 months emergency fund.
2) After that my choice is to go after the 2nd mortgage and put $3500 a month extra on the payment.
3) After that is when I need to decide to double the payment on the house and do the Max Deferred Comp allowed.
OR
Go after the mortgage and when payed off then put the max Deffered comp up and invest the rest?
Just had a talk with a financial advisor today.
Stated to pay off the debts first.
save 8 months emergency fund.
Then go after the 2nd mortgage.
Then refinance the first with a fixed rate.
Then Max deferred comp and $6000 a year Roth.
100% of the home foreclosures are on homes with a mortgage.
100% of the home foreclosures are on homes with a mortgage.
Pay off your morgage, you are close to your retirement. Don’t take any risk at this age.
We owe 120,00 on our house. My wife is retiring soon and will have 125,00 to put in investing or paying off our house. We dont have alot of other savings available. Should we pay off the house. And invest the 900.00 we pay per month on our house loan. Or just keep paying our loan and invest the 120,000 somewhere. We are 60 years old.
Pay off your house . Dont let these financial thieves talk you into anything else. At least you’ll have a place to sleep
Is everyone still as sanguine about making a 10% return on the stock market now as they were in June 2007?
The stock market has always had it’s ups and downs. While I think timing the market is futile for nearly everyone, I haven’t been able to resist myself and have recently doubled my monthly investment into several funds. It’s like money is on sale now!
The most reliable way we have to make decisions about the stock market is it’s past performance, and past performance indicates that we’ll continue to average 10% or greater returns going forward, with intermittent dips. Past performance also shows us that 95% of the 5 year periods and 100% of the 10 year periods, in the history of the stock market have made money, and 100% of the 10 year periods. Which is why if you’re investing for the short term you don’t use the stock market…
I wonder what follow up comments the posters from summer 2007 above would say now that their investments have probably lost 30-50% (or more) in the past 3 months, with no bottom in sight yet. Of course, on the flip side, their home has probably lost a chunk of value as well, but the house provides shelter and has personal practical use beyond its monetary value, which can’t be said for stock. If you’re house is paid off, you can live there for the rest of your life, even if it’s value drops 90% and you get the practical use of it. If you’re retirement investments drop 90% and you still have a mortgage to pay off, say hello to foreclosure.
Is everyone still as sanguine about making a 10% return on the stock market now as they were in June 2007?
People win the lottery, too.
Its November 2008. GM stock has been rated as $0.. worthless. Mutual funds and stock markets are down over 50%. With no end in site! I sold 80 % of my mutual funds in March of 2007 and payed my house off in Texas. I’m glad I did! Texas wasn’t in the bubble and the house is worth more today than when I bought it. If I would have left the money in mutual funds, it would have been worth $300,000 less today. Instead I have great house on the lake in Austin worth more today. I also went cash in a 4% saving account and have just now started buying aggressively in the market again. I have paid all debt off. No house or car or anything. The money I’m investing now in a declining market will pay big in the coming years.
Be debt free. You have many more options in the future. Hey, if you lose your job, you probably won’t lose your house! As we can see in this market with times of huge government spending and borrowing, times are changing.
It’s funny to read the comments from the know-it-alls above about the mathematics of investing and bla-bla-bla. I dare anyone to find a portfolio that has returned 10% annually for the last 10 years! What bull! The last 5 years s&P 500 rate is a negative -2.5%! and before that we had the 2001-2002 crash.
How ’bout just paying your mortgage bi-monthly, once on the 15th and the other at the end(assuming no prepayment penalty) You’d knock down the principle quicker thereby save tons on interest. A 30 year mortgage can be reduced to 22 years with this method. There’s no extra cost involved so the ‘extra’ you would have paid to the mortgage, you can put towards retirement investments.
A bi-monthly mortgage is really the same thing as making 1 extra payment per year. Really you are just arguing to pay down the mortgage instead of investing if you are encouraging bi-monthly payments..
I believe you guys mean ‘biweekly payments’ will pay off the mortgage quicker.. ‘bimonthly’ would be no different than a normal payment schedule..
I read the other comments very quickly, so forgive me if I’m missing someone’s comment. But so far as I saw, I’m really amazed no one has made this very obvious point:
following up on the point made by Stein that paying off a 6% mortgage is equivalent to a 6% return on your investment– and it’s guaranteed– we should also take into account that it’s like earning 6% absolutely tax-free. Because if you’re getting rid of a debt that’s at 6% it’s arithmetically the same thing as earning a 6% return– but crucially it doesn’t involve any income as defined by the IRS!
Now I’ll admit that when I had a house I didn’t overpay my mortgage– I put extra money into the stock market instead (buy and hold, baby!). But I did this in full awareness of the fact that if I could earn 6% in stocks (outside my retirement account), I’d have to pay taxes when I sold, but if I made my debt go down and thus avoided a 6% interest rate on the same money, there would be no taxes. (Seriously: where’s the line on your 1040 to list “how much less I owe on my mortgage now”? If you can’t list it even if you wanted to, then you can’t pay taxes on this “earning”).
Investing might make sense when you look at potential gains. But would you consider taking out a loan (assume reasonable interest) just to put money in the stock market. I don’t think many people would advocate that – even if it was long term. So why do that here.
I also feel better paying off loans. That is why I pay more to my super low interest student loans. Sometimes emotions override pure logic.
I just crunched the numbers between paying off my student loan at 9.10% or saving in an online bank account at 5% the results were suprising. Because of compoundin the total of 1000 saved at 5% for twenty years would be 2,712.64 but paying off my loan early (one payment)would save me 1,174.80 in interst. Of course I still have to caluclate the taxes i would pay on my earned interest but the diffrence is 537.84 greater if I save at the lower rate and i get an interest deduction on the loan so is this emotional or not
Livingalmost,
I can agree with your statement. I get 50% employer match for me 403b contributions, up to 5% of my annual salary. Not great, but $5000 + matching $2500 is the best money available to me right now. I plan on maxing that every year. After that, it seems to me early mortgage retirement is my next best investment, since saving money is not taxable today or ever, but earning money and investing is taxable someday. Make sense? Kind of like diversifying.
Scott main thing about retirement and mortgage is if you aren’t maxing out all retirement accounts before paying off the mortgage you are losing out on valuable time to compound money without paying taxes. Or in the Roth IRA no taxes at all.
I’ve seen this argued over and over. This is the first time I’ve ever commented, but it’s exasperating to see the same comments presented.
By the numbers, paying off the mortgage early or investing is basically a wash. It becomes an emotional decision.
It comes down to three factors:
1. Estimated alternative return. Long-term future return from the stock market is likely to be about 7% (not the 10% commonly quoted). See this article:
http://www.investorsfriend.com/return_versus_gdp.htm
for details. This article is the best explanation around and justifies the 7% annual return number. Don’t just quote 10%!
At 7% the difference between, for example, $1500 invested monthly for 17 years vs. 500 invested monthly for 30 years is pretty much a wash.
2. Volatility. The 7% stock market return is an average. Look at stock market cycles. If you had to cash out for retirement in 1999, for example, it would have been great. If you had to cash out in 2001, it would have been terrible. If you invest all the money in the stock market (no diversification, which would likely reduce the 7% return) then you better be comfortable with risk.
3. Taxes. The mortgage deduction tax only lasts for the first few years of the mortgage payback, and is further impacted by the AMT. There is a difference, but it’s not a huge difference.
Realistic Numbers show this decision is about emotion. The numbers are a wash. If you less oriented toward risk, then you pay off the house and diversify the investments after that. If you are more oriented toward risk, then you stay on the regular mortgage schedule, don’t diversify, and hope you sell out at a high point in the market cycle.
Your choice.
If you’re capable of earning more than 2% more than your mortgage then you should not pay it off.
If you don’t know anything about investing, you’re probably better off paying it down (after you’ve built up a large emergency fund).
If I lived in the states, because of the tax deductibility of the mortgage, I would definitely put the savings to work in the stock market.
It seems all agree that investing beats accelerating a mortgage. However, I think most, (if not all) these comments presuppose that one has a lifetime to let the numbers play out. I have 10-15 years left before retirement, 29 years left on a 30 year 157,000 mortgage, and $30,000 in 403b. For me, accelerating the mortgage makes the house payment much more efficient (putting more back in my pocket) and has the potential of giving me a $200,000 house (appreciation) paid in full before retirement with a small retirement nest egg. Cash the house out and,coupled with my matured 403b, I have $250,000 for retirement. I can’t achieve that with 403b in the next 15 years. Please show me where I am mistaken. I appreciate the advice.
Scott,
I agree with you. I am in a similar position. We’ve got about $142,000 left on the mortgage and with the youngest about to graduate from college, we’re going to take the $ we’ve been sending to him (once he’s settled) and throw 1/2 of it at extra payments on the mortgage and the other 1/2 into a “mortgage only” savings account. Once the balance on the mortgage equals the balance in the “mortgage only” savings account, we’re paying that baby off in one, final lump sum (shaving years off the mortgage and savings thousands on the interest we won’t be paying).
Wouldn’t it save money in the long run to just put all the extra money towards (principle) mortgage payment than putting half towards mortgage and half in a savings account only to eventually pay mortgage? Seems you would pay more in interest by not paying it down as much as possible as quickly as possible. Thanks.
Was anyone arguing that this wasn’t the case? It’s pretty simple math.
The only place where disagreement can arise is the psychological side of it. For most people 90% of personal finance is the psychological side. I mean, really…most of this stuff is very basic math.
For most people being completely debt free is quite the invigorating thing that allows you freedom to do what you want, when you want.
It’s simple math, but it’s based on some risky assumptions. There is no guarantee that you’ll make 10% in the stock market. Many people invest in the stock market and lose money. But the return on paying off the mortgage is guaranteed. The risk factor in choosing the stock market is being ignored in this discussion.
I haven’t verified your numbers, Chris, but the outcome looks right . . . 338k in favor of NOT paying down the mortgage. The 4% difference between your mortgage and your stock returns gave you a big edge over the time period.
With a low interest rate on the mortgage and a high return on your investments, it’s a no-brainer as far as wealth building. Keep the mortgage and divert your free cash to investing . . . unless your investment horizon is short, like less than 10 years. In that case the low risk of the 6% mortgage may be preferable to the stock market, since in a short period your investment in the market stands a better chance of losing money.
So am I looking at this the wrong way?
If I have a $160k 30yr fixed at 6% my payments are $989 a month. I pay $500 extra a month to pay it off early instead of investing, I pay it off in 13 years shaving 17 years off the loan and $115,038 in interest. I invest the monthly payment of 989+500 a month for 17 years and I end up with $796,898 minus a few thousand a year for taxes since I lose my mortgage interest deduction, say a good $50k over 17 years leaving me with $746,898 invested after 30 years.
OR I just put in $500 a month and end up with $1,085,600. All assuming 10% return. A difference of $338k.
Wait! Everyone here is assuming that the market will perform to the “historic norms”. The last 10 year performance doesn’t reflect that. The S&P 500 over the last 10 years has done 2.82% per year – (Ouch). So you might have a low mortgage rate – but I doubt very many people have under 3%.
Anyone who paid their mortgage off quicker over the last 10 years did well – both psychologically and financially. The theory that you will make 10% in the market is seriously flawed. People dont have infinite time horizons. People panic when markets sink (and jump out – thereby locking in their losses). Peoples retirement dates do not necessarily coincide with a market upturn. By comparison, the mortgage is essentially a ZERO risk investment.
Finally – think of it this way – the banks clearly think lending you the money at the mortgage interest rate is a good investment – so what makes you think you are such a good investor that you can do better than the banks.
Something that many people are missing. Often as in the case of most lower cost home mortgages, the so-called deduction is mostly one big JOKE!
Based on my calcuations, the ONLY money you typically save (if ANY) is the money LESS the standard deduction on taxas (you can no longer use) about $6,000, typically and nearly $12,000. married/filing jointly, and then you only actually get back in actual money, usually a FRACTION of that difference. Most people simply don’t realize this until after they buy a home, if ever.
Also, keep in mind that typically you pay about 30% TAXES on most earnings. If you know of a stable and safe one where you don’t, please let me know 🙂
broknowrchlatr,
I love the way you put that. Paying on a mortgage is a low-risk, low-yield investment, and in that sense it is very much a diversification of your portfolio.
Continuing with that reasoning, think about a 30-year mortgage as a 30-year fixed-rate CD. If you have a long time until retirement, how much $$ do you want to allocate to that CD vs. stocks and stock funds? The answer to that is easy . . . not much. And that’s exactly how you should think about extra payments on a mortgage: low-yield investing. Over the long-term, such investments never (at least not yet) do better than the stock market, and it’s not even close. My minimum monthly mortgage payment is enough exposure to this investment for me, since I’m just 27. I can tolerate short-term volatility to get the long-term payoff.
I think the decision has to be taken in context with your oother investments. If you have a 6% mortgage and have all your other savings in stocks, you can count money paid toward that as a lower risk portion of your portfolio. In a sense, it is diversification.
I definately agree with the last statement. You don’t want to be making payments on your home (or car or anything) at retirement.
I think people make this decision a little haphazzardly. If you compound interest of 10% vs. 6% for 30 years, it’s overwhelmingly in favor to stock market. It’s a factor or more than a million dollars in most cases, I believe.
When I think about what’s less stressful, being debt-free or losing a million dollars, the later always comes out on top.
“This simplified answer doesn’t take into account the emotional side of money. Perhaps it shouldn’t, because facts are facts (unless they’re statistics).”
If this was true, then why is called ‘personal’ finance? People’s emotions and character work hand-in-hand with money, at least how money is handled.
“Once you retire and income presumably drops, you don’t want to have that much of a mortgage payment preventing you from using your money for other living or enjoyment expenses.”
Wouldn’t it be nice to have NO mortgage when you have a fixed income? 🙂
I’d sooner pay off the mortgage. Investing may pay off more, but only if I choose the right stocks, or the right funds, and the historical returns accurately predict future returns. When I pay more to the mortgage, I guarantee my interest savings. Plus I get to invest my whole mortgage payment plus my prepayment amount after it ends early. Plus I don’t have to worry about that money and how its doing, once I pay it, I’m done.
Emma: Emotions and character certainlay play a role, which is why people *feel* better about making certain decisions, despite the level of mathematical validity of those decisions for a particular individual.
I wouldn’t expect most people to want to separate their emotions from their handling of money, but I would expect that people try to understand the full consequences of their decisions. If they’re willing to forgo a low-risk future income of (for example) a few thousand dollars a year in order to feel “at ease” earlier by paying off a mortgage sooner, then that’s a perfect, *personal* decision.
This personal aspect is also why one-size-fits-all financial mantras are often bad financial advice.
I completely agree. It would be wonderful to have no mortgage when living off a fixed income. I hope I’ll be in that position. 🙂