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Ever heard the argument that keeping a low-interest mortgage and investing elsewhere is the smarter financial move? Perhaps the common refrain, “Why pay off a 3% debt when you can earn more elsewhere?” sounds familiar.
Dr. Cory S. Fawcett from Financial Success MD challenges this popular belief in today’s guest post. At first glance, it might seem counterintuitive to pay off a low-interest home mortgage. After all, with the allure of potential higher returns from other investments and the supposed tax benefits of mortgage interest, isn’t it financially wiser to keep that ‘good debt’?
But have you ever paused to consider what “good debt” truly means for your life? Or contemplated the tangible freedom and peace that comes from being mortgage-free?
Dr. Fawcett brings a fresh perspective, built not just on theoretical calculations but on real-life experience. Do you yearn for a simpler, debt-free life where financial decisions aren’t just based on percentages and spreadsheets but also on life goals and happiness metrics? Let us read on and discover why the common wisdom about ‘good debt’ might not be so wise after all.
I frequently hear people debating whether to pay off a home mortgage, which usually has a relatively low interest rate, or invest the money. Often the misguided answers to this question stem from only looking at the interest rate for the decision, as if it were the only valid variable. The following are the mistaken answers I repeatedly hear:
Never pay off a 3% debt.
Leverage low interest loans all you can.
Investing it for higher interest is a no brainer.
There isn’t a scenario where it makes good mathematical sense to pay off your mortgage.
Do the math: 6% vs. 3%. Enough said.
There is bad debt and good debt, and your mortgage is good debt.
If everyone followed these recommendations, they would frequently make the wrong decision. Interest rate is not the only variable to consider. There are other factors that are often ignored by those who only read about being debt-free, but have never actually gone through the process of becoming debt-free like I have. There is a big difference between book sense and experience.
I learned about the shortfalls of book sense when I entered my first live poker tournament in Las Vegas. I had played poker online with imaginary money for months, learned the odds of winning each hand and thought I was a great poker player because I was consistently winning the imaginary poker games. About halfway through the tournament, during a break, I spoke with an old guy who seemed to have played in many poker tournaments. I mentioned this was my first tournament. He surprised me when he said, “Yeah, I know.”
How could he know I was a rookie? Because I was making a lot of rookie mistakes which the experienced players had learned to avoid. The same way all experienced people can spot rookies. Doctors who have been in practice for years can easily spot a doctor who just finished residency. They stand out for their lack of real-world experience. I asked the experienced poker player what I was doing wrong. He commenced to tell me about all the things I had done in the last two hours that gave it away. None of the advice he gave me was in any of the books I read about poker.
That’s the way it is in life. You can’t get all the information you need about a subject by reading it in a book or doing the math. There are additional things you need to put into the equation that you don’t realize until after you have lived through it. This is when the other important variables that aren’t in the books are revealed.
The following are some additional variables to keep in mind in order to see the whole picture before answering the question about paying off a 3% home mortgage. I have lived both with a home mortgage and without one and picked up a few things along the way.
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The Scenario
The following is a typical question I encounter almost daily, and is asked frequently by my coaching clients.
I, Toni, received a big chunk of money from a relative. It is just enough to pay off our home mortgage. We are getting close to financial independence. We already have our emergency fund fully funded, we are maxing out our retirement plans, and I would like to go to half-time as soon as possible. With our mortgage, which is our only debt, the half-time budget will be tight. I’m torn between investing vs paying off the debt. Our original loan was for $600,000 at 3% over 30 years with a monthly principal and interest payment of $2,529.62. We still owe $400,000. I want to pay off the house, but my husband keeps saying it’s a bad idea to pay off a 3% loan, we need the tax write-off, and using leverage is smart. What should we do?
Is there a right answer? I think there is.
Cash Flow
Those whose tunnel vision is focused on the interest rate lose sight of cash flow. I learned the importance of cash flow when I began investing in real estate. It has the same considerations here.
Toni would like to work half-time but their current cash flow will not allow it. The house payment costs $2,529.62 every month. She is likely paying at least 33% of her income to taxes. Thus, she needs to earn $3,794.43 a month to have enough cash flow to make the house payment.
Paying off the house is equivalent to an immediate $3,794.43 a month raise ($45,533/yr). If she earns $227,000 a year, paying off the house creates the ability to take one day off each week without any financial ramifications.
If she invested her $400,000 in certificates of deposit paying 5% interest, it would bring in $1,667 per month on average, but she likely couldn’t collect the interest monthly. She would pay the 33% tax and be left with $1,116.67 a month cash flow. Far short of what paying off the house generates.
In fact, Toni would need to find an investment that would return a guaranteed 11.38% before tax to get the same monthly cash flow as she gets by paying off her house. It will be extremely difficult for Toni to find an investment that will beat the guaranteed cash flow she will get by paying off her house.
There is actually no tax write-off for her mortgage interest
Many people believe their home mortgage payment is a great tax write-off. In fact, Toni, just like 90% of the rest of America gets no tax write-off at all for her mortgage interest. We have been led to believe in a tax write-off that doesn’t actually exist for most Americans!
Toni and her husband, being a married couple filing jointly, will get a $27,700 standard deduction on their 2023 taxes. The interest on their remaining $400,000 mortgage balance at 3% will be about $12,000 this year. They will also likely get the maximum $10,000 SALT tax deduction (State And Local Tax deduction limitation). Their $12,000 mortgage interest deduction and the $10,000 SALT deduction come to $22,000. Since their $27,700 standard deduction is greater than their itemized deduction, they will take the standard deduction instead of itemizing their deductions. In doing so, they will not get any tax write-off for their mortgage interest.
It is estimated that in the 2022 tax year 90% of taxpayers used the standard deduction. That means they were not able to write off any mortgage interest. Since about 63% of Americans have a home mortgage, but 90% of all taxpayers cannot take a mortgage interest deduction because they will use the standard deduction, there are a lot of people mistakenly thinking they get a write-off for their home mortgage interest.
We need to stop perpetuating the misbelief that people get a tax benefit from keeping their home mortgage, since most do not. Couples who do get a write-off, don’t get as much as they suspect since the first $27,700 written off on their Schedule A doesn’t count.
Bankruptcy
The risk of bankruptcy is zero if you have no debt. Bankruptcy is the action that happens when a person has no way to pay their debt. No debt = no chance of bankruptcy. It doesn’t matter if you acquired the debt from borrowing to buy a house or undergoing a medical emergency generating a large medical expense you can’t pay. Bankruptcy is about debt you can’t pay.
This is left out of the equation from those who talk about keeping the mortgage and investing the money elsewhere, possibly even in something super safe.
We have recently seen some banks fail. It happens from time to time. Banks can get over-extended just like people do. When you are over-extended and can’t cover your bills, bankruptcy happens. What happens when your super safe investment was in a bank that declared bankruptcy?
Your savings is FDIC insured up to a point. But that money will likely be accessible after a waiting period as the insurance payments get sorted out.
Investing the money is not guaranteed
Many people will tell Toni she should put the money somewhere to earn more interest than she is currently paying on her loan. If she leaves it there for the life of the home mortgage, she will be slightly better off mathematically than if she used the money to pay off her home mortgage.
Unfortunately, this is not how the scenario usually plays out. If Toni pays off her mortgage, she gets guaranteed results for many years. But the money that gets invested at a higher interest may not have such a good outcome. If something comes along and we see that big chunk of money just sitting there, we may decide to use it for something more “productive” than earning interest. So, we buy a boat, a new car, a vacation home, pay for a wedding or take a fantastic trip.
Now the side of the equation that is collecting “higher” interest isn’t collecting any interest at all. This is the problem when both sides of the equation are not real. Paying off the mortgage locks in a return that investing the money does not.
The power of now
If I ask which is better to have $10,000 now or $10,000 later, almost everyone will say having the money now is better. Now has a lot more value than later. Using the $400,000 to pay off the house has an immediate effect on Toni’s pocketbook. She gets the immediate effect of having a $3,794.43 a month raise, by no longer needing to earn the money to pay the mortgage payment and the income taxes. That is a raise of $45,533.16 a year. Many people would uproot their family and move for a $ 45,000-a-year raise.
Taking the option to keep the mortgage and put the money in an investment paying higher interest is based on letting all of the money ride until the mortgage is paid.
This assumes you will continue to pay the house payment at the lower interest rate and keep the investment at a higher interest rate so that many years from now you will have a slight difference in net worth. By then your net worth will be so large that the difference between the two options will not likely matter.
We must find a balance between having financial effects now vs later. We can’t stop going on vacations simply because saving that money instead of spending it on a vacation will increase our future net worth, allowing us to be able to retire sooner and go on more vacations later in life. Vacations can’t all be saved up until we retire simply because it creates a mathematically higher net worth. With the logic usually used for paying mortgages early, there is no mathematically logical reason to ever take a vacation.
Making the assumption that the right answer is always the one with the highest net worth at retirement is missing the point of living life. Some money needs to be used now for enjoyment and some of the money needs to be saved for the future when we can no longer earn a living.
Using this money to allow Toni to switch to working half-time and enjoy her life and family more by working less will create a huge deposit into her happiness factor with minimal change to her future net worth. The bigger hit to her net worth will come from earning less income by working half-time, which Toni has already determined is an acceptable outcome. If she is willing to take that big financial hit, then the small one between investing vs paying off the house is irrelevant.
Both options, paying off the house or investing the money, have the exact same immediate effect on Toni’s net worth: It increases by $400,000. Paying off the house will then increase her happiness for the next 20 years. Investing the money will likely create a minimal increase in her net worth at retirement.
Since Toni has already almost reached FI and is ready to decrease her workload, the best overall use of this money is to help her achieve the lifestyle she has been working toward. This is the final move to push her over the threshold to realizing her goal.
That “good debt” is killing you
I think the most important argument is not about the amount of money gained, but about the power you gain from this opportunity. Toni says she wants to cut back to part-time, but the household budget is currently too tight to allow her to take this step. If she paid off the house, she could comfortably switch to working part-time immediately. That is power! She can’t switch to part-time if she invests the money anyplace other than paying off the house.
She has the chance to make a big change in her life right now if she pays off the house, but she will have to continue to work and earn more money if she chooses to keep the house payment. Many people don’t catch hold of this concept. They are burning out at work because someone convinced them to keep their “good debt.”
That “good debt” may be all that is standing between having a long life as a part-time doctor or burning out, which may lead to quitting and losing all their future income potential. That will be a far greater loss of money than you could ever gain from investing the $400,000.
I feel strongly that there is no such thing a good debt. All debt is a burden. Sometimes it is a burden we can live with, like the mortgages on my apartment buildings, and other times it comes with a very high price tag. In this case, keeping the “good debt” will keep Toni from switching to half-time and living her dream. Don’t let “good debt” get in the way of living a great life now.
I once coached a doctor who planned on keeping his home mortgage and retiring in five years. But if he used the cash he already had in the bank to pay off his house, he could retire immediately. He only needed to work the extra five years so his retirement accounts could grow enough to make the house payment with a 4% annual withdrawal. When he realized what paying off the house with the cash he had saved would allow him, he retired a month later.
If you are struggling with the issue of paying off your house vs investing, then get a copy of The Doctors Guide to Eliminating Debt and look at more than just interest rate arbitrage. When you include how you want to live your life in the decision-making process, you can make an informed decision. If you only look at the interest rate, you may make a mistake and miss out on a great opportunity that could have changed your life. Eliminate interest rate tunnel vision so you can see the whole picture.
27 thoughts on “Yes, You Should Pay Off That 3% Home Mortgage”
“It will be extremely difficult for Toni to find an investment that will beat the guaranteed cash flow she will get by paying off her house.”
I don’t agree with this at all. The cash flow arguments (which seem to be the basis of almost the entire article) assume the $400k needs to remain invested the duration of the mortgage. It doesn’t need to be a one-time, instantaneous investment. You could easily invest in a CD or bond ladder that matures monthly, use the interest + principal that matures each month to pay the monthly payment, and still come out ahead in the end, even considering income taxes paid on that interest. Bonds/t-bills also have additional tax benefits, e.g. US treasuries which are exempt from state taxes. You could even get more cash flow if that was what was important to you.
I know the title was just meant to grab attention, but I really wish it would have been “when it may make sense to pay off that 3% mortgage.” The points about cash flow, taxes on earnings from the $400k, mortgage interest, etc. are all good ones, and things people should consider when making this decision, it just feels like the author had an agenda and decided ahead of time they wanted to argue that you should always pay off a mortgage.
Why pay off debt if the interest is tax deductible like a home mortgage?
Alexis,
Like I explained in the article, most people do not get any tax deduction for their home mortgage interest, but they all think they do.
Clarify please: “We need to stop perpetuating the misbelief that people get a tax benefit from keeping their home mortgage, since most do not. Couples who do get a write-off, don’t get as much as they suspect since the first $27,700 written off on their Schedule A doesn’t count.”
Are you saying that if I itemize the first $27,700 of interest is not tax deductible?
Does this apply to loans for commercial properties as well as home loans or home equity loans?
Michael,
If you don’t have any deductions at all, you get to write off $27,700. So the only actual benefit you get from write offs on Schedule A, like home mortgage interest, occur only after you deduct enough to reach the $27,700 standard deduction. Everything after that is a write off benefit. This applies to any loans on your home or even gifts to charity.
This does not apply to commercial property interest which is deducted on Schedule E and is always fully deductible. That difference in how the interest is written off is one of the reasons you should pay off your home mortgage before paying off your rental house mortgage.
Thank you for your new view and discussion of this topic. Our chips are down right now and we need to take the real decision on how to play them.
Husband and I are self employed, kids grown, near FI. We recently settled my parents estate and our share is almost exactly enough to pay off the only debts we have: low interest mortgages on our home and two rental properties. ‘Good’, low, fixed interest mortgages.
We are self employed in a time for money business – we generate an income when we show up, but nothing while we sleep. So paying the mortgages off will increase our cash flow now, reduce pressure on us now, and will enable us to take more time off now. I love your discussions of vacations. You can’t save them for the future.
My grandparents worked hard to buy and pay off a modest home. When my father inherited his share, it was just enough to pay off the mortgage on the house we lived in. My parents paid it off, never took on another debt, and they enjoyed the cash flow and freedom from debt for the rest of their lives. I raise a toast to my parents and my grandparents, Their financial discipline in paying theirs off in 1945 and 1975 has opened the door for me to do the same in 2023.
I have spent many hours recently reading up on this topic and thinking it through. I have done the math multiple times, and still reached the point where I feel real peace with the prospect of paying the mortgages off rather than investing. Even the 2.5% one.
Abigail,
Since you have real peace with the decision to pay off the mortgages, you don’t need any more information or advice. You know what you need to do, so do it. Keep in mind that you win no matter what decision you make in this case. I love that you have such a great opportunity. Sorry it came in this form.
Interesting that a serious investor gambles at poker. I love the state lotteries as in most cases it’s the only place where poor people pay state taxes. These geniuses think by buying $20 or $30 dollars worth of lottery tickets per week they will eventually win enough to retire. This same $100/month placed in a Roth IRA will give them more retirement money in 20-30 years than they are ever likely to net from spending it on tickets and winning anything.
David,
I never gamble playing poker. I play in poker tournaments only. I pay an admission fee and then have a few hours of fun entertainment until I either get knocked out or win some money. Paying $60 to enter a poker tournament in Vegas is the same as paying $60 to go to a show. Either way I get entertained for a couple of hours at a known cost. But I’ve never won any money at a show. Incidentally, I won that first tournament I discussed in the article. I have the tournament champion jacket in my closet as proof. I do love playing cards and play poker, pinochle, hearts and five crowns most often.
I think a lot also has to do with cash flow. We are building our dream house, and I am fortunate to have a fixed income pension. However, even with the sale of my previous house and savings, I would have to dip into my 401 to the tune of about $200,000. Personally, even in today’s high interest I would much prefer to take out a small chunk every month to pay the house payment. Plus at 61 I will never see the house paid off. Even if I did it is just at that point an asset that I will be passing on so personally I would rather have the cash and use the money in my 401 to make the house payment. Especially with a defined benefit pension. I think that really changes the calculus on whether or not to pay the house off because you have a guaranteed income stream. Just my two cents. Great article.
Dublin,
As long as you have the cash flow, you can do it any way you want and all will be well. Congratulations on building your dream home.
Thank you Cory for a fresh perspective on a never-ending debate! A couple of thoughts on the matter:
1) We have chosen not to pay of our 2.5% mortgage for now. I fully understand and appreciate your cash flow perspective. To me, the main issue is flexibility. My life experience has taught the most difficult financial challenges are the ones you don’t see coming such as unexpected repairs, emergency trips, health care expenses, job loss, etc. a fixed predictable house payment is generally the least likely thing to cause trouble. An emergency fund can handle a lot of this but refilling it can be a nervous challenge we have learned. Also, sometimes it is not a crisis but an opportunity (e.g., dream house, new job opportunity)that comes up and having liquid funds can allow more immediate action then a heloc or second mortgage. We prefer to have funds more liquid than tied up in home equity for now.
2) the other thing is that many people treat this as an all or nothing decision where either you pay off your house or invest. You can and should do both! We could payoff our house tomorrow but instead are paying extra on it and investing. A general principle I have followed in finance is if there are two good options but it is unclear which one is better now, do them both if you can until it becomes clearer which one is better for you. We follow this same principle choosing to invest a pre-tax and Roth 401k during each year because it is very hard to know which one is going to be better until further down the road.
Thanks again for another great thoughtful post and thanks for all you do!
I also chose to do both. I was maxing out my retirement accounts and put all the left over money each month into paying off my debts. Worked out well. I was debt free 8 years out of residency.
Great article. I personally am choosing to invest rather than paying down my 2.5% mortgage. Money is automatically transferred to my brokerage account to make sure I don’t overspend and I’m fine with market volatility.
Since I’m in my early 30s, compounding will continue to have a huge impact for me long term. Over 30 years, even with a conservative 8% return of S&P 500, it’ll significantly outperform paying off my 2.5% mortgage
However, if I’m like 45 or older, I see the merits more of either doing a 15 year mortgage or paying off the mortgage quicker given the range for compounding isn’t as great as it was in earlier years. I’m likely to pay off my current mortgage during the last five years for this reason
Shawn,
Sounds like you have a good plan in place. Best of luck to you.
My wife was just complaining about the $500+ payment on her car that’s still on a 0% loan from the dealership. It was smart financially to take that deal but still impacts monthly cash flow and is an annoyance more than anything.
That being said anyone in a fresh 30 year sub 3% mortgage should hang on to that. Cash flow might be an impairment now but with inflation I bet those same monthly payments will seem nearly free in 20 years.
NH,
You can’t ignore the current cash flow need simply because it will be alright in 20 years. That’s like telling the parents of new triplets that they shouldn’t get that bigger car they need right now because in 20 years the kids will be in college, and it will be alright then.
I too have done a zero percent finance of a car thinking it was a great financial move. The $1,000 a month payments were enough of a burden that I later wasn’t so enamored by the deal. Especially since the amount of money I made on the car loan interest differential was pretty minor.
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Agree, but I wish these kinds of articles didn’t always ignore property taxes and insurance. Surely that $2,529.62 house payment includes taxes and insurance that will never go away ($600-ish?). There’s no such that as free lodging, even with a paid off mortgage. You can lose your home, even without bankruptcy, if you don’t pay your property taxes. But the bill without the mortgage is certainly more manageable, and I get what you’re saying about cash flow.
A Hilton the taxes and insurance were not ignored in this example. The payment discussed was only the principal and interest on the loan. Many of us do not have our payments going through escrow and thus pay our property taxes and insurance separately, as in this example. You are right that those cost will still continue after the house is paid off. Those costs were not relevant to this discussion because they were accounted for elsewhere in her cash flow needs. I only included the discussion of what was going to change her cash flow. Thanks for your comment to let me clarify that.
great article what were the poker tells that gave away that you were a newbie?
Tom, they weren’t poker tells. It was how I behaved at the table mostly. In fact the pit boss came to me 2-3 times and told me if I did that again I would get kicked out. I saw how people would play with their chips on TV and when I played with my chips, I put them in my hand and leaned back in my chair, thus taking the chips off the table. That is a big no-no that got me reprimanded. You play with your chips only while they sit on the table. Another one was not putting a token on my cards when I play them. If a token is on the cards, you are playing, if not you are folding. I actually had the dealer swipe away my cards once because he thought they were folded as there was nothing sitting on them. It was stuff like that.
interesting! i love the metaphor for this article
I agree most use the standard deduction. I took our mortgage as new investment expense. Our home had been paid off for 15 years. Borrowed one million, segregated into a separate checking account and used those borrowed funds for interest paying investments. Didn’t expect interest income to become as lucrative as it is but for us, cash flow is not an issue.
Mary, cash flow is KING. If you have enough, like I’m glad you do, then you can do just about anything with the rest of your money and do well. When cash flow is tight or not enough for what you want and need, then the pinch becomes great. Today I really benefit from the cash flow generated from my real estate investments, which exceeds my monthly expenses.
Thank you, this is one of the best articles I have read on this subject.
Our mortgage is 25% of our monthly expenses. I continue to struggle with whether I should pay extra every month vs investing all surplus funds in the market. This article was helpful, although in my situation, paying down a little extra principle every month is not as sexy as paying off the whole mortgage right now.
JB, you are welcome. I paid off my home mortgage as a larger payment each month. After four years (2001) I had no more mortgage. It is very sexy to pay it off all at once and see the results in next month’s cash flow. But it was still pretty sexy to pay it off in only a few years and become debt free decades before it would have happened naturally.
Kudos to JB for the advice! Paying off a mortgage early by making larger monthly payments is incredibly empowering. While it’s tempting to make a one-time big payment, gradually becoming debt-free in just a few years is an amazing achievement. Financial freedom is truly sexy