After having gone through several financial planning books and a financial planning class, one thing we've been considering doing for a while now is paying off our home early.
There are a lot of pros and cons to paying off your home mortgage early, and today I thought we could examine what some of them are.
Paying Off Your Home Early
If you've saved for your retirement and put money away for your children's college expenses, you might be considering paying extra on your mortgage, and paying off the home early.
There are a variety of ways you can do that. One suggestion is to get no more than a 15 year fixed rate mortgage, that is no more than 25% of your income. If you don't already have a 15 year fixed mortgage, now may be a good time to refinance your home with the “Making Home Affordable Refinance Program“. A 15 year mortgage may mean higher payments, but it also means you'll be paying the loan off earlier, and you'll be paying less in interest. Pay it quicker that 15 years, and you'll save even more because most of the interest is paid at the front end of the loan period.
You can also just keep your current 30 year mortgage and just make extra payments if you're unable to refinance for whatever reason.
By paying off the mortgage early you're also going to be giving yourself a huge peace of mind knowing that your house is paid off, and if the worst happens, you'll be able to get by on a whole lot less. After all, the house is paid for!
Arguments For Paying Off The House
There are a lot of arguments surrounding whether or not you should pay off your house, and whether it really is the best thing to do psychologically and financially. I know I won't solve that debate here today, but I thought I would look at some of the points in favor and against this plan, so you can make the decision for yourself.
Points in favor of paying off the mortgage early:
- Interest Savings: You'll be saving thousands of d0llars in interest payments on the mortgage. For example, on a 200,000 dollar mortgage over 30 years, with an interest rate of 6%, you'll end up paying over 250,000 in interest. Cut that to a 15 year mortgage and you're only paying 115,000 in interest. The faster you can pay the mortgage up front (when you're paying the most interest), the less interest you'll pay!
- Less Risk: By prepaying your mortgage you'll have less risk in your life because you'll have a paid off house. When you have a paid off house you have a lot less to worry about because you know you'll at least have a place to live as long as you cover the few bills you have left. Plus, trying to beat the the benefit of pre-paying the house by investing the extra money instead means added risk because investing isn't a sure thing. (As we've seen for sure these past few months.)
- Peace Of Mind: Having a paid off house means having peace of mind. I don't think the importance of that can be underestimated. Having debt of any kind can really be a extra weight on your shoulders, and it can weigh you down. Don't underestimate the psychology of personal finance, and that burden is very real. Remove it and you will feel a lot more free to save, invest, build wealth and give!
- Less Stress: You'll have less stress when having to deal with a job change, or wanting to have a spouse stay home to raise the children. Because you have a paid off house you'll only have a few small bills to worry about. You'll have walkaway power – power to walk away from any job you don't love or enjoy because you only have minimal expenses!
- It's Like Getting A Raise: Without having to pay that large bill every month, it's like getting an instant raise! You can take the extra money every month -and start investing!
On another site, I read a story of someone who has paid off their mortgage. It really emphasized why paying off a mortgage can be a good idea.
A friend of mine is in his mid-thirties and paid his mortgage off completely. This allowed his wife to quit work and stay at home to raise their three children. They have no other debts, and he recently took a lower paying job because it brought him more satisfaction at the end of the day. He wasn’t trapped by an enormous mortgage, or saddled with other debt. Being debt free allowed his family to make these decisions to live the life they want to live, not live the life they are force to live to just to repay debt.
Being debt free brings freedom, and sometimes that's better than a few extra dollars made through investments.
Arguments Against Paying Off The House
- Liquidity And Flexibility: By not prepaying your mortgage and instead investing the money, you are more liquid in your holdings. Your money is more accessible if it is in investments as opposed to in a house. This can give you some flexibility if you need the extra money. Of course, having your 3-6 fully funded emergency fund should preclude needing any large amount of money right away.
- Investing Returns Could Be Higher: If your expected returns on your investments will be higher than the interest and money saved by pre-paying, investing instead of repaying may be the better choice.
- Inflation Works With You: As inflation goes up by 3-4% annually, by not prepaying you are in essence paying less for the house every year. You pay the same in 2039 to live in your house as you are in 2009. So basically you're getting more for your money as time goes on.
- Lack Of Diversification: One could argue that paying off your house first means you're investing in only one type of asset, and unnecessarily means more risk. Better to invest in good mutual fund where your holdings are diversified, instead of investing in only one thing, real estate.
The arguments against paying off the house first do have some merit. It really makes the decision a tougher one.
When looking at all of the arguments in favor and against paying off your house early, both sides of the debate make valid points. That makes the decision on what to do a tough one.
On the one hand, the psychological and peace of mind benefits of paying off the house early are very apparent and powerful to me. I can't even imagine how freeing it would be to pay off our house, and to have all that extra money every month to save, invest and give away to those in need. Complete debt freedom would be amazing!
On the other hand if you look at the numbers logically, not paying off the house early really does seem to make more financial sense. With a historical stock market return of almost 12% in the long run, there aren't many cases in which prepaying the mortgage can make more financial sense. In fact, if you're looking at a 15 to 20 year window of home ownership, in the past an investment in the S&P 500 index would have been a better investment 100% of the time!
Still, it comes down to weighing the benefits, the risks and balance sheets on both sides of the equation. For me, after considering both the financial and emotional/psychological sides of the equations, I'm still coming down on the side of pre-paying the mortgage. It just seems to me to be such a powerfully motivating goal to have – a debt free life. I really relate with the story I linked above about not having a house payment, and the freedom that brought to the family – being able to have one spouse stay at home, and having the power to walk away from a job that wasn't ideal.
While I realize that some may do better financially by not paying off the house, to me it is more motivating to be living a life without debt and to have the freedom that goes along with that. The few extra dollars we might make by investing the extra money instead doesn't matter as much to me. The answer may be different for you.
Another idea? Do a combination of the two paradigms, pay a little extra, and invest a little extra!
What do you think about paying off the house early? Do you think it's a good idea or a bad idea? Which path are you choosing if you're at that point? Tell us in the comments