When I said debt-free, I didn’t mean having a zero or positive net worth with assets equal or greater than debts. I meant I didn’t want to owe nothing to nobody. Positive net worth, zero debt.
My decision wasn’t based on mathematical modeling. I didn’t cycle different scenarios through a spreadsheeet.
It was a personal decision. A psychological decision. Nothing more.
I had taken on some serious debt and paid some serious interest. While chipping away at my student loan debt, I added a half-million dollar construction loan. With an initial interest rate above 5%, I was on the hook to pay more than $25,000 a year in interest on that loan alone (getting some of that back as a tax deduction at the marginal tax rate).
I wanted to be done paying interest. I wanted to truly own the things I pretended to own and I wanted it to happen by my fortieth birthday.
It almost didn’t happen.
The Math Behind Paying Off Your Mortgage
For the most part, I ignored the math, although I knew in my head what the consequences of mortgage payoff would be.
At a 5% interest rate and a 40% marginal tax rate, I was effectively paying about 3% a year on the principal. This was true because I had itemized deductions.
If you take the standard deduction, which will be much more common with the increased standard deduction resulting from the Tax Cut and Jobs Act, you are paying the full mortgage interest rate, getting no deduction on the interest you pay.
If your itemized deductions barely surpass the standard deduction, you’re essentially deducting very little of your mortgage interest. It’s good to know where you’re at with deductions.
Back to the math, where I had plenty of itemized deductions. Assuming the principal that I owe is working for me and invested in my portfolio, I would need at least 3% returns in a given year to break even on carrying the mortgage.
Perform better than that (should happen) and carrying the mortgage wins. Underperform 3% returns (tough to get a guaranteed 3%) and mortgage payoff wins.
The math is simple. With today’s low (but climbing) interest rates, I would say carrying the mortgage wins more often than not from a probability standpoint. From a psychological standpoint, being debt-free is a state of being that has significant value that’s much more difficult to quantify.
I chose the option to be debt-free and haven’t regretted it one bit.
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The Math Behind Paying Off Student Loans
The other heavy debt burden carried by many of us are student loans. The payoff calculations are similar, but not identical for the high-income professional.
In the lower tax brackets, student loan interest is tax deductible. The deduction is phased out at an adjusted gross income of $70,000 to $85,000 for individuals in 2019 (double that if married, filing jointly), an income most physicians will exceed.
Just like the tax filer who takes the standard deduction pays full fare for mortgage interest, those of us with strong salaries pay every penny of our student loan interest without a tax benefit.
If your loans are at 6.8% and you are not pursuing a loan forgiveness plan like PSLF, you should consider refinancing your loans. Otherwise, at that high interest rate, you would need returns exceeding 6.8% to break even on carrying those.
I had consolidated my student loans to a low interest rate, but chose to pay them off with a lump sum that came in the form of a signing bonus a few years shy of my fortieth birthday.
The Plan to Be Debt Free
Every goal needs a good plan, and mine evolved as our situation changed. We actually moved a couple of times and bought a couple more homes. It’s a long story.
Eventually, though, we realized we were holding on to the past which was making life in the present more difficult and potentially jeopardizing our future as we were basically hemorrhaging money. I had been funneling all my locums earnings towards the mortgage, but the balance was around a quarter million, and wasn’t going to disappear soon.
Meanwhile, we bought the home we currently live in for half of what we put into that dream home, paying cash. When I was about 39.8 years old, after about a year and a half on the market, we finally sold the one-time dream home for a $200,000 loss plus realtor fees. 4,000 square foot waterfront homes don’t sell as well after the only hospital in town shuts down.
The day we closed was one of the worst and best days of my life, financially speaking. We lost a ton of money that day (or at least realized the loss). We also became free.
Although I could have considered us to be financially independent based on the home equity, it didn’t feel real until the home was sold and the money was in our hands.
A couple years earlier, I paid off the last of my student loan debt with a lump sum payment from a generous signing bonus. When we sold the house 10 weeks shy of my fortieth birthday, we were officially 100% debt free.
Should You Pay Off Your Loans or Invest the Difference?
Many a blog post and forum thread has been written addressing the question, and I could fill a page with links to the various discussions on the hot topic. I won’t do that to you, but here are a few:
- WCI Forum: Mortgage vs taxable investing
- WCI Forum: Pay off mortgage or invest extra funds
- Bogleheads: Anyone regret paying off mortgage?
- Bogleheads: To pay or not to pay off mortgage?
- Bogleheads: Investing vs. Payoff Mortgage
Ultimately, the answer depends on a number of factors. Some are simple math. Are they high-interest loans? Is the interest tax deductible and are you in a high tax bracket? Do you think you can get a better return elsewhere?
While I likely would have come out ahead if I had drawn out my student loan payments, taken out a mortgage on our current home, and invested the difference, I don’t really care. We only know this in hindsight. The market has performed well in recent years, and after I paid off my debts, I had plenty of money to invest.
Yes, I sleep well at night. Not on a huge pile of money (sounds uncomfortable, honestly), but not under a crushing pile of debt, either.
How much would it cost you to pay off your loans?
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Do you have dreams of being debt free? Have you realized them already? Do you choose to use your low interest loans as leverage to invest in the markets? Let me know below!