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
I’ve read a lot of arguments against paying off the house on other blogs. I have to admit that many of them make a good argument against paying off the house. Some of the better ones:
- 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
We’re actually hoping to move this step along by refinancing to a 15 year or a 20 year loan. (15 year is preferable.) Interest rates have almost hit that points where they are 1.5% below what we have right now. Crossing our fingers…
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Harry Inslee says
Thanks for these helpful real estate tips. Real estate purchases go all the way back to the time of Genesis. Abraham insisted on paying the full price for the plot of land that would be his wife Sarah’s burial site, even though he could have gotten it for free. The full citation is at bibleconomy-dot-com
The Happy Rock says
I think the point is tied to some of the other positives, but cash flow is a major win. Instead of shelling out thousands a month, you are free to direct that money anywhere you want. It is like getting a $20,000 a year raise.
You can also consider the tax benefits of mortgage interest too, although often that is a misleading ‘disadvantage’. You can get the same write off by giving the money to a charity rather than the bank.
I fall completely on the pay it off ASAP side. I want to use my money and my stress/energy for things that serve others and bring me joy.
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What price do you place on the ‘peace of mind’ because ultimately that is what it comes down to. Let’s say you have a 30 year mortgage and you decide that you can afford to make additional $x payments every month and payoff the mortgage in 20 years, at let’s say, 6% rate of interest. Also, let’s consider the alternative of investing $x everymonth in a S&P index fund in a separate ‘paying of house in 20 years’ account and realistically expecting 12% average return over the same period of 20 years. In this scenario, I would recommend to invest these excess dollars and at the end of 20 years, payoff the remaining mortgage using your investments. You will still have money left over in your investments this way as you earned a higher return than the rate of interest you are paying on the mortgage.
End result is the same, you paid off your house in the same amount of time either way. You probably had greater peace of mind when you invested as your money was more liquid.
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I too fall on the side of pay it off ASAP. About the last argument against paying off early, if you are following the Baby Steps, then you are already putting 15% toward your retirement, so by paying off the house you are diversifying your portfolio further (adding real estate to the mix) rather than being un-diversified.
I am all for paying off the house as soon as you can; as long as its where you want live for a very long time!
We have moved from Florida to CA to Nevada to Texas to Georgia to Indiana; all in the last 10 years because of my husband’s job; and have own/sold our home each time. After many years of doing that, we have finally decided to buy a home – where we want to live and retire – and pay it off.
It will be sooo nice to have that burden lifted from out shoulders; knowing we have a place to live; no matter what happens in this economy.
Ryan Loos says
I am in favor paying of the home early. Remember that when it comes to personal finance it is not always about the returns on investment but we must let our heart lead us and 9 times out of 10 our heart will lead us to the paying of the home early. As far as not being diversified enough, if you are at this baby step you have 3-6 months of expenses in cash and you are investing 15% of you income in good growth stock mutual funds for investing. As Dave says the best investments are real estate and mutual funds!
My wife and I bought our first house in June 2002 which was right before the price of houses went up dramatically. We put more than 20% down. We both work in an industry where we are at constant risk of being let go so for peace of mind we more than doubled our house payment which allowed us to pay of our house in December 2007. I read so many articles and blogs about why paying off the house early was not a good idea but I knew that for us it was the right decision. Most of those articles and blogs said that it wasn’t a good idea because you are tying up your money in a house and that it would be better to diversify. Of course, when they say “diversify” they mean to spread your money out in various kinds of mutual funds. Well, had I listened to them my money would be sitting in a mutual fund somewhere right now and would have lost half it’s value. But paying off our mortgage early has allowed us to save cash unbelievably fast and that gives me and my family a peace of mind in this terrible economy. I don’t have to worry about losing my house. I don’t have to worry about losing my job but even if I do we can continue to send our kids to a Christian school. Living without a mortgage is just “right” in so many ways. I don’t want to be perceived as a nut but after maxing out my 401k for years and years and seeing it drop it’s value so rapidly so many times I’m only contributing what my employer matches now. I know there are tax consequences for doing that but it just seems to me that the whole stock market thing is a big scam – they’ll tell you that the market has averaged over 10% growth… really? It sure doesn’t look like it when I get my 401k statements. The bottom line is that the bulk of my money is going in to CDs and some in gold because at least there I know my money isn’t going to vanish. And I know that I never have to worry about taking care of my family. I’m not convinced that I’ll realize a higher rate of return by investing in the stock market and even if I would I wouldn’t trade the peace of mind that I get by having my money in cash. I understand that by making less than 3% on a CD that I’m actually losing money when you take in to consider inflation but if I lost half of my 401k (or mutual funds) from a bad economy would I not be way ahead if that money was in cash? Lastly, and most importantly, I believe that God put it in my heart to pay off our house early and it’s truly been a blessing from Him. He’s been so loving and wonderful to my family (even when I haven’t been very lovable). Thank God for the work of Jesus Christ and the grace he has given us!
Joanne K. Morse, Ph.D. says
My church has us preparing for the possibility of a financial collapse. They believe if you can be debt free you will be able to handle whatever happens. Apparently during the depression, those that did well owned their homes and were able to grow some food items.
As a church we are all trying to stock up with 6 months worth of food for ourselves and 6 months worth to give to those who aren’t prepared.
I figure if I can pay off my house I can save the money until needed and I can share my home by offering someone a place to live if needed.
It’s a little scary taking all that money out of retirment acts but in the end I think I will feel safer.
Greg T. says
No one mentioned that the borrow is slave to the lender. That includes mortages. People somehow have got the notion that there is ‘good’ debt and ‘bad’ debt. Granted, there is some debt that is worse than others, but debt is debt and the master – slave relationship is there.
I have weighed the pros and cons as well and I can’t seem to shake the security of what a paid off house is like. I setup a blog at http://www.payingoffmyhouse.com to keep me motivated towards my goal. I know if I have this in to keep updated it will encourage me to finish my goal. I am in the process of refinancing to a 15 year loan, I can’t believe how low the rates are right now.
I know a few people who have lost their jobs and they are facing the horror of a forclosure. I think this is the kicking point for me to be financially secure with a paid off house. I can see how quickly a job loss could make you end up homeless on the street. I never want to have the happen to me.
I am currently on baby-step 3 and in a couple months I will start paying off my mortgage. I can’t wait to see my statements to see how much is going towards interest and how much is going towards principal.
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Franklin Carbon says
The whole idea of prepaying your mortgage ahead of time in my opinion is the best thing that ever happen to a family who is under financial constrain.
As much respect as I have for Dave Ramsey and his work, I take exception to the fact that his math isn’t very sound in his book when he talks about debunking the myth of not paying your house down (page 188 of Total Money MakeOver). His argument goes something like this:
borrow $100k @ 8% and invest at 12%
1st year you would pay $8k in interest, and make $12k. Dave goes on the say even though it looks like you made a $4k profit, that you have to pay taxes on the 12k, and if you are in the 30%, that’s $3600 (or $2400) at capital games. So, instead of $4k, you’d be making $400-$1600.
First, I’m not sure where the $2400 comes from. Long term Capital gains (at the time of writing) was 10-15%. That’s only $1800. Further, he didn’t include your mortgage deductions on the $8k, so if you’re in the 30% bracket, that’s worth an extra $2400, so the profit loss for paying off your house vs. investing would be:
$4k – 1800 (taxes) + $2400 (mortgage deductions) = $4,600 yearly (compounded)
Other notes: I think 12% is a little high today, but so is an 8% mortgage at the moment.
A previous replier mentioned something about paying off your house means you’re invested in real estate, which is more diverse. You actually have more of an investment in real estate with a mortgage, since the appreciating value (your house) grows with a smaller investment (your current equity in the house).
Having said that, I think there’s nothing wrong with paying down your mortgage debt. For many people, it might make sense, from a security standpoint. What I think is more important, is that the author of the blog post pointed out it doesn’t have to be all or nothing, you can do a little of both. I think the important things are:
– As Ramsey points out, not to have a big mortgage payment as a ratio of your income. I think he recommends 25% of take home pay? If you are at a higher level than this, you should definitely consider paying down. One, because you will probably get a better rate, but also you want to be ensured that if you had to sell your house for some reason, you wouldn’t have to owe money after realtor fees.
– If you do keep a larger balance on your house, you have to be disciplined enough to actually invest the difference (most people’s problem), but also you need to take the extra risk into consideration when deciding how much extra emergency income you need.
In the end, it’s hard to put a price on piece of mind, and paying off your debt is a guaranteed profit, vs. the market which has fluctuating returns.
The argument always comes down to what your money can earn elsewhere, instead of paying down your mortgage. The S&P 500 offers a diversified exposure to the US stock market, so it might be one of the places you would elect to put your money. From Mar 2, 2001 through Feb 26, 2010 (a nine year period), the S&P 500 return was -11.34%. That’s not close to the guaranteed return (the interest rate on your mortgage) you would get in paying down your mortgage.
Glendon Cameron says
This is an argument for paying off the house early. Everyone is speaking of what you lose in terms of capital gain, investment income, tax saving and so on. I will speak on what you gain by not having a mortgage.
Peace of mind!
The keep a mortgage crowd is all well and good if most people were actually putting that money towards investments, most are not and the average American does not even really start investing ( if ever) until the age 38-40 something.
So if they paid their house early they would be in a better financially position just from that move alone. I looked at eight ways from Sunday.
I know people who live in homes that are paid off and during this downturn they were the most stress free of the my friends. But these folks are also live within in their means and carry little to no debt.
I was chatting with one who bit the bullet and paid his house off in ten years. He was getting ready to go on a two week trip to Europe , he said it was the best move he ever made. He does have a house payment but his renter is covering the mortgage on that one.
I will be in a financial position to pay cash for a house this year and I am going to do it, because I truly want to be a home owner for once!
We have one more payment, we tripled our payments and will soon be debt free – talk about having extra money each month – which will probably disappear quickly considering we have 2 in college but they won’t need to go in debt and neither will we! We are also free to give over and above 10% to our hearts desire. I can tell you its worth it no matter what! Even if you can only make 1 extra payment a year – do it!! Set up autopay for a little extra principal every month even if you don’t thinks its much and you’ll never miss it!
Glenda Lundak says
I recommend keeping a 30 year loan but paying more. You can pay your tax returns towards your home loan once a year or you can mail a little extra each month.When it comes to a bank, you can always pay more but you can’t pay less. You don’t want to end up in a foreclosure line. Life has a way of changing our plans in mid stream, there are no guarantees. You must consider job loss, divorce, child with health issues, bad economy, major home repair. Just to name a few. Don’t put yourself under to much pressure financially.
Peter Anderson says
That’s the route I took with our home loan. We have a 30 year, but we’re making extra payments on our mortgage at least once or twice a year. I like the flexibility of doing it that way..
We have dumped a lot of extra $$ at our mortgage for the past 3 years. Got it to the point where only 20% goes to interest and 80% is principal. Was planning to finish it off next year, but now we are faced with the possibility of paying tuition for our kids to go to school, so no extra $$ for mortgage reduction. BUT look what we’ve accomplished- saved thousands in interest by paying extra in the early years when most of the payment was interest. Even if we pay the minimum from now on, we should pay off the house within 3-4 years (10-11 total), long before retirement.
Okay, now here’s my beef- why do people always want to assume a 30% tax bracket when they make up examples? We make in the low/mid $40K range and we fall into the 10% bracket after deductions and exemptions and such. To fall into the 30% bracket you’d have to have a 6-figure income and/or no kids, and that just doesn’t apply to most people. If you want a realistic scenario, try assuming a 15% tax bracket at most.
I am currently on Step 6 of Dave ramsey’s baby steps. In fact, that’s where I started because I already had an emergency fund/investments.
I am trying to pay down my $86,000 mortgage by age 30.
I think Dave’s advice is great. I’m using money that’s already coming in to tackle this debt at a rapid clip.
If I didn’t put it toward the mortgage, I would be tempted to spend it.
I made this goal because I want to switch to a less lucrative, more rewarding career soon.
Check out my blog to see my progress. I’m at nearly 80K already!
As to paying off the house early or not, compromise and just go with a 15 year mortgage and pay that off on time. Just because you don’t “pay it off early” doesn’t mean a 15 year mortgage is a bad thing. You are still paying it off faster than you neighbors who hold a 30 year mortgage. Time that 15 year one right and you may be mortgage free by the time the kids start college (that’s my goal). You don’t want to constantly have to tell your kids “no we can’t go on vacation this year” or “we can’t afford XYZ” because you are putting it all toward the house. I’d rather pay a few extra years on the mortgage and have extra liquidity and the ability to splurge a little every now and then.
The financial end of this has been pretty well hashed out. But the Bible’s call is to good stewardship in everything, not just money.
A house should be considered primarily as a place to live rather than an investment. The investment end can be an added benefit, but not the primary influence.
If you have young children and decide to save money for fifteen years living in a rented space, by then you don’t really need the extra space anyway and have lost much of the benefit of the space compared to the cost of financing.
A very important element of risk management was not even addressed as well. In the event of a lawsuit, a mortgage could actually serve as an added protection to keep your home from being confiscated.
Debt itself isn’t necessarily evil. There’s a huge difference between a loan that serves as a tool and indentured servitude/loan sharking as rates go above 20%.
My wife and I paid off our mortgage about 9 months ago. I am 33 and she is 34. We did it through a combination of aggressive payment using my salary (about 20%), selling a rental property we had previously paid off (about 30%), working a side job and using almost all of those funds to pay down the house (about 30%), and a small inheritance (about 20%).
It still took us around 11 years from when I bought our first house with a $250,000 loan (we moved once but rolled the equity into our current home).
I thought that I would feel a great “pressure lifted” from my shoulders when the house was paid off. Surprisingly, that’s not really what happened. I found that my relative stress level and anxiety stayed pretty much constant, even after the house was paid off.
Since my job is pretty stable, I’ve never really worried about being able to make mortgage payments. As a result, the amount of relief I thought I might feel from a payoff never really happened. I was actually a little surprised.
Financially, though, it is nice to not be paying $3,000 a month (we were massively over-paying every month), so that money is “extra”. So far we’ve used it to remodel the basement and are starting to save to remodel the two upstairs bathrooms. We are also investing in our kids’ college savings plans as well as in a separate investment account really just focused on our future with nothing in particular in mind.