Should I Payoff my Mortgage Early?

You will often see articles on how to payoff your mortgage early.  People seem to make up their minds it’s the best course of action.

What about the question: Should I pay off my mortgage early?  Here is my take on both sides of the argument.

The Answer

Reasons NOT to payoff a mortgage are: It’s an inflation hedge, you can write off the interest, maintaining liquidity is important, and the money would be better off invested in higher yielding opportunities.  Good reasons to pay off a mortgage include peace of mind and primary residence equity having special protection from creditors and bankruptcy in many states.  Poor, but often cited reasons to pay off the mortgage are decreasing expenses and gain a risk-free return equal to the interest rate.

I rushed through listing these answers. I go into more detail below.

Before You Payoff a Mortgage Early

We will assume you have an emergency fund, your high interest debt like credit cards is paid off, and you are fully maxing out all retirement savings account opportunities.

This means you are contributing the max to your IRA, your spouse’s IRA if you have one, and your 401K, TSP, or equivalent vehicle.  You should not bother paying off a mortgage if you have not done these basic things first.

In the end, I’m partial to keeping the mortgage.  I feel like the evidence is strongly stacked against keeping it. 

It’s a little ironic, because I paid off  my primary residence in 6 ½ years.  I also have 20 paid-off single family homes. 

Yeah, that’s a little psycho.

This certainly qualifies me, however, to make a fair judgement on the subject.

Since I’m partial to keeping the mortgage, I’ll explore the pros of keeping the mortgage first.

Keeping the Mortgage

from activerain.com

A long term fixed-rate mortgage is an inflation hedge

If you rent the same property for 30 years, what are chances your rent will stay the same as it was the first year.

No chance.

With a mortgage, you lock in that payment and it stays the same, while rents and the price of everything around you raises with inflation.  This is how mortgages are an inflation hedge.

You can write off the interest

When you carry a mortgage loan on a property, not only do you get a very low interest rate (at least these days), but you can write off the interest if you are able to itemize your deductions.

Liquidity

One of the big problems with having all of your money tied up in a house is, it’s not a liquid asset at all.

That means, you cannot get money out of it quickly when you need it.  The main way to get your money out of a property is to sell it.  From beginning to end, that can takes months.  It also has high transaction costs.

By instead putting your money in other investments like stocks, bonds, or mutual funds, the money can be quickly converted to cash should that need arise.

Invest the money – Opportunity Cost

The opportunity cost of paying off your mortgage vs your options is just too high.

Paying off the mortgage saves you the interest rate.  That’s nowhere near what you could make if you invested in the S&P 500 or a similar index fund long-term. 

I invest in real estate.  My investments do better than index funds do. 

I’d choose between the stock market or real estate before I paid off a mortgage again.

Payoff Your Mortgage Early

Here are the arguments for paying it off.  The first two I’m not huge fans of.  They are often cited arguments, but they don’t hold water. 

Paying it off decreases your expenses

The argument here is, by paying off your mortgage you have less expenses.

This may be true, but it’s extremely simplified thinking, and shows a lack of understanding of the power of compound interest and investing over the long-term.

If you would have taken the money that you used to payoff your mortgage, and put it either in index funds or in good real estate investments, you would more than likely have a substantial sum of money. Eliminating a mortgage would pale in comparison to what you could do with your newfound wealth. 

It could allow you to travel, visit friends, donate to charities, etc. 

Gain a risk-free return

Again, I’m not a fan of this particular argument.

The argument goes, by paying your mortgage, you guarantee yourself a savings of the amount of the interest rate on the loan.

That may be true, but at what opportunity cost.  How much money could you have made investing the money elsewhere over the long-term. 

Don’t forget about the magic of compound interest and the magic of leverage and tax benefits of investment real estate.

The next three are definitely better advantages of paying off a mortgage early that I can agree with:

Equity gets special protection for bankruptcy

Sometimes, this is called a homestead exemption, and it exists in some, but not all states.

This is designed to protect the equity in your home should you file for bankruptcy.

It protects creditors from taking the equity in your home away from you in a bankruptcy proceeding.

Home equity can also be excluded from consideration in certain circumstances where you are attempting to qualify for Medicaid for long-term care or for other situations.  Your other assets would be counted against you.

Peace of mind

Peace of mind is arguably the most important reason for someone to payoff a mortgage.

It’s the reason I paid off my mortgage, and also the reason I bought my investment properties in cash.

But at what cost!

I can speak for my case.

It is quite likely that I could be wealthier had I purchased far more property using leverage, instead of the twenty I purchased with cash.

But that’s probably an unfair argument.  It’s easy to look at the past and say you should have done something. 

If the market would have tanked, I would have felt like a genius for paying in cash.

My point is, my regret is because I now know the outcome of my decision to be conservative.

Most people aren’t getting the tax write-off

While it is true you can write-off the mortgage interest tax, this will end up not being available to most taxpayers.

Under the 2017 Tax Cuts and Jobs Act, signed by President Trump, the amount for the standard deduction almost doubled.

This means, you need a lot more to write-off before you can itemize your deductions.  The typical homeowner just won’t be able to.  The tax does apply to second homes and vacation homes, so this may be a little easier for the wealthy to take advantage of. 

Aren’t taxes great! (Dare I ask for comments on this?)

So, there it is.

If peace of mind is important to you, then the financial reasons that make it obvious not to pay off your mortgage early don’t matter.

I used to think it was awesome to have everything paid off.

As time progresses, I wonder why I didn’t use more leverage, much more leverage, to responsibly invest in real estate.

The question of should you payoff your mortgage ultimately goes to what’s important to you.

Peace of mind?  Build wealth quickly?  Something in-between?

What do you think?

Read my post on 5 Secrets to Payoff Your Mortgage Fast

Rich on Money

2 thoughts on “Should I Payoff my Mortgage Early?”

  1. Rich,

    Leverage is great when it’s non-recourse but unlikely to secure for an individual buying SFR. The risk of leverage turning against you or any individual is too risky due to the long term of a mortgage in my opinion.

    Look forward to the next post.

    Semper FI,
    Luis

    Reply
    • That’s a good point. Glad you’re able to post! I’ve heard that in order to put mortgages in an IRA, you have to get non-recourse loans on single family homes. I guess it’s possible, but not easy.

      Reply

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