Is paying off the mortgage early a mistake? Or could it be a smart financial decision?
Today, we have a guest post from a co-nominee for the Best New Personal Finance Blog at FinCon in 2017. Neither of us won the Plutus Award, but the nomination alone was an honor.
That recognition is not the only thing we have in common. There’s also the fact that both of us chose to be debt-free rather than carry a mortgage in spite of the math that would suggest it’s not the smartest financial move. Why? I’ll let Rob explain, after a brief introduction, which he kindly supplied.
Rob of Mustard Seed Money is an accountant for the federal government with a passion for all things personal finance. He created the website Mustard Seed Money and the course Reaching FIRE. Both of which emphasize sound financial education and advice.
I think most of us would agree that money gives us security. With enough money, you don’t have to fret about the little things, and you can freely make spending decisions. However, more specifically, I believe that being debt-free gives me a heightened sense of security.
Buying a Home
Shortly after I graduated from college, I felt ready to buy a house. I was earning a decent paycheck, I planned to stay in the area for the foreseeable future, and I had quite a few friends who were eager to move out of their parents’ basements who could be potential housemates.
So in 2004, a little over a year after I graduated from college, I bought my first home at the age of 23. What could go wrong?
I thought I knew everything there was to know about finance. After all, I had graduated with a finance degree in college. In reality, I had no idea what I was doing. I took out what seemed to be a huge, but reasonable, mortgage. Trying to be aggressive, I selected a 15-year mortgage in order to lower the interest rate to 3.5%.
At the time, the real estate market was on fire. I figured that if I didn’t jump in then, I might never be able to afford a house. Looking back now, 2004 was close to the peak of the market. Had I needed to sell the property in 2010, I would have done terribly. Fortunately for me, I didn’t need to sell the house and still live here 13 years later.
Astoundingly, a mortgage company loaned $400,000 to a 23-year-old who barely made 10% of that. Keep in mind, this was the early 2000s. The downside was that I could only afford my monthly payment if I brought in some housemates. As an introvert, I felt both terrified and excited. In one sense, I would essentially gain built-in friends to hang out with. On the other hand, I would become an instant landlord with additional burdens and responsibilities.
If you’re thinking about taking on a few roommates, especially if they are all men, I’d encourage you to contract a regular cleaning service. Otherwise, you run the risk of your place morphing into a frat house. A cleaning service will force your housemates to pick up a little bit, so you don’t eventually find a rat’s nest under one of your roommate’s clothes. I probably ended up saving money, even with the cost of the cleaning service, by avoiding household damage due to neglect.
15-Year vs. 30-Year Loan
It was an easy decision for me. I have always hated debt, so I wanted the shortest loan possible that I could afford. Plus, I had plans to make extra payments each month to pay it off more quickly. I didn’t want this debt to limit me in the future.
Too many of my friends carried student loan debt. I saw first-hand all of the ways that debt hindered them, all because of a decision that they made at 18. I didn’t want a decision made at 23 to come back and haunt me years down the road. Instead, I chose to be proactive by eliminating my mortgage as quickly as possible.
Investing vs. Paying Off Mortgage Earlier
Many financial advisors promote investing money in the stock market instead of paying off your mortgage. Historically, the stock market has yielded greater returns over time compared to the historic lows of mortgage rates.
In fact, since 1928, the stock market has had an annualized return of almost 10%, including dividends. Unless your interest rate is over 10%, which we haven’t seen since the 1980s, it would make sense to invest in the stock market.
Even with this knowledge of the stock market outperforming my interest rate, I decided that I would rather lock in and pay off my mortgage. No matter what, there is a risk with the stock market. It made more sense at the time to diversify my portfolio and treat the saved interest expense from paying off my mortgage early as a treasury bond with a guaranteed rate of return.
So I locked in a guaranteed rate of return of 3.5% right? Not quite. When you factor in the mortgage tax deductions, it drops from 3.5% to 2.9%.
What If… I Didn’t Pay off the Mortgage Early?
Let’s explore what would have happened if I had invested that money into the stock market instead of paying off my home. If I had purchased the S&P 500, back when I bought my house (June 2004) and held it until I paid off my mortgage (December 2012), the total return from the S&P 500 would have been 46.04% with dividends (Source: DQYDJ). On face value, that would have been a higher compounded annual rate of return at 4.6% with dividends reinvested versus the 2.9% from paying off my mortgage early.
I went a step further with huge help from ERN, from Early Retirement Now, who calculated that if I had dollar-cost averaged the $900, the actual return would not be 4.6%, but actually 5.8% when you consider all the dips and dives that the market took during this period ***
Therefore, given the difference between the two figures, I theoretically would have had double the return if I had invested in the stock market (5.8% vs. 2.9%).
Some days I wonder how much further ahead I’d really be. However, I am confident with the decision I made. While daunting and strenuous to pay off the mortgage, by the end of 2012, I was able to breathe a sigh of relief. I had reached my goal of paying off my house and felt an incredible sense of accomplishment. I finally had some excess cash at the end of every month that I could freely choose how to spend. It was at that point that I felt like I could start enjoying my hard-earned money.
More importantly, no longer having debt allowed me to relax at work. I was no longer uptight or worried about losing my job or a demotion. Therefore, I took more chances at work, which involved taking riskier positions in order to move up.
While I may not have come out ahead when you solely compare paying my mortgage off versus investing the stock market, I believe I came out ahead when you factor in my salary increase and bonuses that I received.
I also factor in the peace of mind of never having to worry about a mortgage payment again. Hence, there are more variables involved than just stock market returns and mortgage interest rate figures. This is why I am still an avid proponent for paying off your mortgage early.
[PoF: If I was still carrying a mortgage, I’d probably celebrate the arbitrage of carrying tax-advantaged low-interest debt while investing in index funds with a higher projected return. That was my line of thinking for years.
However, now that I have been debt-free for several years, I better appreciate the “sleep at night” factor and behavioral finance aspects of living a life indebted to no one.
If you enjoyed this post, be sure to check out more great articles from the author at Mustard Seed Money.
p.s. Pictured above is one of the homes we actually stayed in during our recent 23-day trip to Hawaii.]
It’s a great feeling to pay off a mortgage loan, and it’s also great to get the mortgage you need at the best rate possible when first starting out.
Physician mortgage loans are being offered by more and more banks. Whether it is a good option for you really depends. I discuss my experience using a doctor mortgage in this post. The three main features you will see with most physician loans are:
- No PMI despite a down payment of only 0-10%.
- Special treatment for the student loans (usually that they only take required payments into consideration).
- Will close before you start working by accepting a contract, instead of paystubs, as evidence of future earnings.
Are you interested in a physician mortgage loan? The individuals listed below offer physician mortgage loans for these lenders and are paid advertisers on the blog. We appreciate hearing feedback on these advertisers, both good and bad.
Thank you for supporting those who support this site and our charitable mission. Some of these lenders also offer loans for other high income professionals such as dentists, veterinarians, attorneys, podiatrists, optometrists, accountants, and others. (Lenders- if you would like your name and contact info listed here, contact us for a quote.)
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Consumers Credit Union:
Contact: Greg Wierenga (NMLS #1636813) at 616-446-2567 or [email protected]
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Contact Ken Roos (NMLS# 436834) at 412-951-6793 or [email protected]
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Contact Jim Webster (NMLS #658933) at 240-620-1414 or [email protected]
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Contact Sandi Jameson-Frith (NMLS#564023) at 586-749-8355 or [email protected]
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Contact: Jason Knight (NMLS# 301141) at 803-231-8441 or [email protected]
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Contact: Mike Wagner (NMLS #801156) at 817-304-7681 or [email protected]
South State Bank:
Contact for approved states (email preferred)
Contact: Jonathan Brozek (NMLS #850168) at 916-788-7982 or [email protected]
AR, KS, MO, OK
Contact: Jim Secrest (NMLS #1104170) at 913-634-2323 or [email protected]
Contact: Moses Luevano (NMLS #1426259) at (855)4BankMD (422-6563) or [email protected]
BB&T now Truist:
BMO Harris Bank:
^ NMLS # 399797
**Equal Housing Lender. Member FDIC.
Have you ever thought about paying off your mortgage? What are your reasons to do so or not to do so? Share your thoughts below.